OMNOVA Solutions Inc. (NYSE:OMN)
Q2 2016 Earnings Conference Call
June 29, 2016 11:00 AM ET
Kevin McMullen - Chairman, President and Chief Executive Officer
Paul DeSantis - Senior Vice President and Chief Financial Officer
David Begleiter - Deutsche Bank
Roger Spitz - Bank of America Merrill Lynch
William Hoffman - RBC Capital Markets
Daniel Rizzo - Jefferies & Company
Rosemarie Morbelli - Gabelli & Company
Ladies and gentlemen, thank you for standing by, and welcome to the OMNOVA Solutions Second Quarter 2016 Earnings Discussion. For the conference, all participant lines are in a listen-only mode. There will be an opportunity for your questions, instructions will be given at that time. [Operator Instructions] As a reminder, today’s call is being recorded.
I’d like to turn the conference over to your host, Mr. Kevin McMullen, Chief Executive Officer. Please go ahead, sir.
Thank you, 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 second quarter results which reflect the hard work we have been doing to improve company performance and continue to drive 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 second quarter.
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, see our most recent earnings release and investor presentations published periodically on the company’s website.
Here is a quick snapshot of our second quarter. We earned an adjusted $0.18 per diluted share, well up from the adjusted $0.11 in last year’s second quarter, marking the 5th consecutive quarter of the year-over-year EPS improvement.
Adjusted operating profit margins grew by 310 basis points to 12.7%, driven by our cost reduction initiatives, improved mix, and pricing, as well as declines in raw material costs. Trailing 12-month Adjusted EBITDA reached $83.7 million, up from $75.5 million at last year’s second quarter end.
Cash provided from operations was $21.1 million in the 2016 second quarter favorable to last year by more than $3 million. As a result of the increased profits and improved cash generation, adjusted leverage was 3.5 times compared to 4.2 times at the end of last year’s second quarter.
We saw good volume growth in a number of our key specialty businesses, including coatings and elastomeric modifiers, as well as in our tire cord, antioxidant and reinforcing rubber businesses. Oil and gas volume was nearly flat, as our geographic market, product, and customer diversification efforts began to gain traction. Overall, volumes were 2.9% lower than last year’s second quarter, driven primarily by expected declines in volume in our paper business.
To bring you up-to-date on the many actions and initiatives that are driving our performance improvement, I’ll turn the call back over to Kevin.
Thanks, Paul. We’re pleased about the progress in our second quarter. This progress positively reinforces the further improvement actions we continue to take.
As Paul mentioned, we delivered significant improvement in a number of our key financial metrics, most notably earnings, cash, and leverage. We believe those improvements are indicative that our strategy is bearing fruit albeit in the early stages. We’re seeing the positive impact of our cost reduction initiatives and we’re beginning to see consistent volume growth in a few key specialty businesses, such as our global coatings.
We’re also encouraged by the result of our oil and gas business during the second quarter, as our volumes appear to be recovering. We’re pleased with the ongoing progress in our performance materials product line, which includes paper and carpet. The contribution of profitability from performance materials was positive and up dramatically, marking the 4th consecutive quarter of year-over-year improvement in response to our cost reduction initiatives, mix, and pricing actions.
Although we’re making progress across the company in a number of key metrics, we know our work is not done, we have more opportunities. We’re driving for consistent positive volume growth across all of our specialty lines of business.
In previous calls, we have discussed our progress in refining our commercial and innovation excellence strategies, capabilities and processes, which will be key contributors to driving sustained specialty volume growth.
Last quarter I reviewed our enhanced new product development process to help you better understand our strategy around developing and launching new higher margin specialty products that are focused on higher impact, higher return specialty markets. Many of these new specialty products are built on platform technologies that can be leveraged across many applications and multi-generational product plans extending and maximizing the value we can deliver to our customers and markets.
Many of these new chemical products are showcased in last quarter’s call and in the earnings release issued today were front and center in the second quarter at major trade shows around the world for specialty coatings, nonwovens, and pressure sensitive tapes.
Likewise, our specialty laminates business recently took advantage of the unique trade events that provided the opportunity to tell our story to a broader set of influential retail and restaurant owners and designers. We highlighted our noted signature performance in highly durable, lower cost, lower maintenance, and flexible design solutions for fixtures, display, tables and seating, floor, and distinctive architectural elements, such as three-dimensional wall and ceiling decor.
Our new chemical and surfacing products are receiving positive reaction from our target customers. While the selling cycles in these markets can typically extend many months to years, we’re confident we will begin to see incremental sales growth later in 2016, which will continue to build support for sustained specialty volume growth in 2017 and beyond.
I’d like to spend a few minutes outlining our strategy to enhance the capabilities and processes that formed the foundation of sales excellence at OMNOVA Solutions. We have strengthened our sales team with a number of targeted organizational moves over the past 12 months. Among them, we created a new performance chemicals head of global sales position to drive world wide sales capability and process improvements.
We promoted two of our top seasoned sales directors to lead our regional efforts in North America and Europe. And given the critical importance of China, Southeast Asia, Japan and Korea to our growth strategy, earlier this year we hired a new regional sales director for Asia Pacific. We’re supporting sales excellence with a variety of cost effective selling tools.
One example is, our recently enhanced company website at www.omnova.com, we have integrated the latest thinking around use of digital technology and marketing to attract a greater number of quality leads for our sales team to pursue and to create lasting linkages with customers through content targeted at their needs and interest.
Enhancements in our selling organization, capabilities and processes are designed to increase our focus on developing deeper and broader relationships with our large existing customers through key account management and solution selling. We see significant headroom to grow with our larger existing customers across a variety of applications. In addition, we see growth with targeted prospective customers where their needs closely match our capabilities and unique value propositions.
At the same time to better meet the specific needs of our smaller account, we have moved them under the care of our inside sales force, which is co-located with our marketing team. Key to our ability to be successful with customers at all levels is the unique position OMNOVA occupies in the value chain in many of our markets.
Industry consolidation over the years has compelled many of our larger competitors to focus predominantly on high volume applications. We believe there’s a void in the market we can fill in a number of specialty markets because of our unique capabilities and service model.
OMNOVA has the size, scale and capabilities to provide innovative solutions oriented products and technologies for demanding high value applications. Yet we’re not too large, we have the flexibility and the willingness to work closely with customers to provide the differentiated solutions they need to make their products standout in the marketplace.
This unique position we hold in the value chain as a global specialty supplier together with our enhanced sales team, capabilities and processes has already resulted in improvement over the past few quarters. We expect this improvement to accelerate as our initiatives gain further traction.
Looking now at the third quarter and beyond, many of you are likely aware of a national strike in France in June at the beginning of our third quarter. This impacted one of our OMNOVA’s primary French raw material suppliers, causing a disruption at our operations in France, including the need for OMNOVA to source material from our alternative suppliers.
As a result of this disruption, we expect to have a one-time unfavorable impact to EBITDA of $2 million to $3 million in the third quarter. This situation is improving and the company currently expects it to be resolved by early July of 2016.
Also in Europe, we expect the impact from Brexit to be minimal on OMNOVA. We have no manufacturing assets in the UK and our sales there make up less than 2% of our total global revenue.
In summary, we are encouraged by our improved financial results, as we continue to make clear progress in delivering our strategic objectives. We expect ongoing profit growth will be driven by our specialty businesses in both performance chemicals and engineered surfaces to increase volumes from the introduction of innovative new products and the strengthening capabilities of our commercial team, as well as through margin expansion from cost reductions, mix improvement and pricing actions.
Additionally, we continue to successfully manage our performance materials business to increase profitability and cash flow as we have been doing. As we work through the second-half of fiscal 2016, we continue to expect another year of significant growth in adjusted diluted earnings per share.
Thank you. Paul and I are now ready to answer any questions that you might have. John, if you could please open the lines for questions.
Certainly. [Operator Instructions] And first from the line of David Begleiter with Deutsche Bank. Please go ahead.
Hi, good morning.
Kevin, can you discuss a little bit of – about the SB latex market? How are pricing actions going? Would you see operating rates right now and how is demand?
Yes. So as we mentioned in the script, here in the comments, we’re very encouraged by what’s going on in our North American SB business. We’ve taken a lot of cost out. We’ve taken utilization. We’ve taken capacity down. So utilization rates for the North American SB business are north of 90%.
Earlier in the year, we were able to get positive pricing actions as contracts came up, which was a very positive development. And so, while we will continue to monitor this, we continue to think that paper will be in decline from a structural standpoint. We think there are opportunities for us to improve that cash and profit generation that we can get from this business. We continue to have very targeted and focused new product development, but in a much more focused way that will enable us to continue to retain our business there.
So I think a much better environment. It’s been one of the biggest challenges the company has faced over the last two to three years. And we feel like we have come along way and really and put a floor under that business and expect to improve profit generation and cash from that business going forward.
In Performance Chemicals, Kevin, would you – how do you grow this business longer-term on a profit basis, given the headwinds from a declining paper market?
Well, I think one thing for sure is our specialty business is our front and center in terms of our growth, our innovation, our new commercial capabilities. And this is a new OMNOVA paper no longer is the dominant part of our company. It – it’s down to about 11% of our sales today from where it was before north of 30% before we did the Eliokem acquisition.
So we’re very focused on accelerating growth in our specialty business. And our focus there is to grow, both top line and bottom line in our specialty businesses, both in engineered surfaces and chemicals and to grow earnings in our performance materials business, which is largely paper and carpet.
Thank you very much.
Our next question is from Roger Spitz with Bank of America Merrill Lynch. Please go ahead.
Thank you. Good morning.
Good morning, Roger.
In the past two fiscal years, fiscal Q3 EBITDA was down to about $17 million to $18 million from $20 million – $21 million to $22 million in the past two years – past quarters since last two years, mainly driven by Performance Chemicals. Do you expect the same pattern this year? And is there a seasonality driving here and all those, I guess is separate from the $2 million to $3 million impact from the butadiene supply disruption in France this year?
Yes. So this is Paul. So, our expectation is, when we look at 2016 and what’s driving 2016, we’ve got cost reductions. We’ve got margin improvement. We’ve got our pricing action improvement, and we have some growth in some of our core specialties like coatings or elastomeric modifiers that have really good margin.
So, we talked about having significant growth in our earnings year-over-year. And so, as we look forward, a lot of those effects continue. If you remember what happened to us last year, oil and gas fell off the map at the end of the third quarter for us last year. And so, as we rolled the business forward, our expectation is that, we continue to see the effects that that we are seeing in terms of those primary drivers to our results.
And so, our goal obviously is to continue driving the business on the path that it’s been on. We’ve had five quarters of growth now in a row on an EPS basis over the prior year. And certainly, we understand that successful companies are able to maintain trends like that for the long-term and that’s what we’re driving for.
Thank you for that. In the first fiscal 2016, corporate EBITDA was $13.7 million – expense, excuse me. Is this is a good run rate for the second-half of the year and for 2017?
Yes, corporate expense bounces around a little bit. So in the corporate expense this year, we have deferred comp plans that get mark-to-market. And those deferred comp plans being mark-to-market just as the stock market has run up, that’s had an impact on expenses at corporate, which is why it looks a little larger than it would otherwise.
So, I would say that, we don’t expect that component to continue. Corporate, excluding that and excluding true-ups and incentive comp would not be up all that much. And so, I think, if you look at that run rate, I think, it’s a little higher than on a go-forward basis.
Okay. Lastly, fiscal 2016 CapEx, is that still $25 million to $30 million is the guidance?
Yes. Yes, we’re going to stay with that guidance for right now.
Thank you very much.
Next go to Bill Hoffman with RBC Capital Markets. Please go ahead.
Hi, guys, thanks, and good morning.
Kevin, can you just talk a little bit more – you’re obviously seeing some of the benefits of the consolidation efforts you’ve done here in the SB latex market in North America. Do you feel like all that benefit has flowed through, or do you expect incremental as you go forward?
No, we absolutely expect incremental going forward a lot of the savings that we got from the plant closure really just happened during the second quarter. So throughout 2016, we expect the total of $8 million to $10 million in savings and then an additional $3 million to $4 million in savings in 2017 from all of our footprint and other cost restructuring actions that we have taken. So we think there’s certainly more ahead in terms of benefit.
And would you quantify how much do you think you got in the quarter in the second quarter?
Yes. So I think we’re somewhere in the $3 million range in the second quarter, which would put us at the higher end of the range for the full-year.
Okay. Thank you. And then second question, just in regards to Europe and Brexit, et cetera, you said that obviously how many assets in the UK in a small part of the business. But if you look more broadly across Europe, any thoughts on the negative economic impacts and potential for economic malaise over there and sort of how you deal with that?
Yes, I think there’s always the potential business just create more uncertainty in those markets and does that lead to some slowing of demand. I think there’s a direct impact and there’s knock-on impact. But we don’t see really much impact in our business in our markets from the direct.
On a more broader standpoint could there be some slowing, yes, I suppose. But we find ways of growing our coatings business on a global basis there as well as the other parts of the world. And we continue to believe there’s further opportunities to do that as we get more effective at our selling capabilities, our marketing capabilities, we have a lot of headroom in terms of the market – share of market position in the markets we serve.
So I don’t want to say we’re immune to market softness, it helps all the competitors in the market. But given our focus is really on bringing new innovations to the market and substitution of existing products in the marketplace. We think we have opportunities to grow even with a relatively flat market conditions there.
Great. Thank you. And then just last question on the carpet chemicals business, have you seen any improvement there and/or do you expect to see any as you go forward?
So I think margins are certainly up in that business and cash generation from that business, given the restructuring we’ve done. I think demand is still tepid I would say, and I think it will improve as the housing market continues to gain some improvement. We think we’re still in the early to middle innings of the housing market recovery.
And so I think that will help. But obviously there’s some substitutionses that are happening with solid surface. I think the good news for us the largest growth market for any flooring category is luxury vinyl tile that’s in the south surface category. And in our engineered surfaces business, we’re very well positioned to pickup incremental growth in that business by serving the luxury vinyl tile market there.
So I think going forward, I think from a carpet alone standpoint, I think residential carpet will be flattish. I think commercial carpet will see some growth. There’s an opportunity for us to grow our position in commercial carpet, but historically we have underserved that segment. But we have projects underway to develop products to better serve that commercial market that will be growing going forward.
Great. Thank you. It’s helpful.
And next go to Laurence Alexander with Jefferies. Please go ahead.
Hi, good morning. This is Dan Rizzo on for Laurence. Given the challenges with the paper end market and the improvement in profitability though, is there a chance or is it possible that you could potentially sell the performance materials business. Is that something that’s I mean doable?
Yes. So I think our focus is – in all these cases is what’s the right opportunity for OMNOVA. Our view is that it’s a pretty consolidated industry. And so that makes a little bit more difficult from a sales standpoint, given there just aren’t – there aren’t many competitors in the industry.
So our focus has been to improve the contribution from that business and we’ve made steady progress four consecutive quarters of progress of doing that and we believe we can continue to do that. If like we always are looking, if there’s a better opportunity for our shareholders from the standpoint of who owns the assets, we will always look at down. But I think those opportunities are pretty limited in the paper space.
Okay, thanks. And then I think you indicated that coated fabric sales in China were weak in automotive. Is that a destocking issue, or is it just a trend or what’s going on there?
Yes. So we’re – there’s some destocking going on. There has been some slowing in China. But overall, we still expect the China automotive industry to grow and it’s a large market we expect it to grow going forward to have considerable unit growth.
We’re ratcheting down one of our larger customers that we’ve had from a supply standpoint and growing rapidly with local OEMs in China. And so that’s what’s contributed to some of the decline as we move through this transition. We’re still quite confident. The opportunity is there, but there’s some transition period that we’re moving through. We’ll continue to move through for the rest of the year.
Okay. And then finally, inventory revaluations were I think is $500,000 tailwind in the quarter. What’s the outlook going forward for that?
Yes, so that’s a good question. So we’re watching butadiene and styrene. Those are the two that are really driving the performance of that right now. So as we look at that, we have a couple of effects going on that that have an impact on that. So we’re not expected a kind of volatility.
If you remember last year, we had big drops in styrene and butadiene pricing. We’re expecting it to be much more stable to up this year as we go forward. So I think where we had some tailwinds last year, we’ll probably be flat to maybe some headwinds or, I am sorry, we had headwinds last year probably flat to some tailwinds in the latter half of the year. But it really depends on what’s happening with those movements from month-to-month in styrene and butadiene, as well as us driving our inventory levels down.
So we’ve taken seven days out of working capital. Inventories are pretty big component of that. And so, as we drive that down, that will lessen the volatility from these movements as well, and so that’s certainly something we’re paying attention to.
So, one thing I would add to that that Dan is that, over the long haul, we’re very encouraged by trends in butadiene, although there will be movements in price up and down. But as North American market has become the ethylene kind of capital of the world with low cost gas and more ethylene projects coming on, a byproduct of producing ethylene is the molecules that go into butadiene.
So this is an era. We believe we’re in now, where butadiene will be a very attractive liner [ph] from a long-term standpoint, given the things that have happened overall in the petrochemical industry and these new projects that are coming on-stream for ethylene.
All right. Thank you, guys.
[Operator Instructions] And we’ll go to the line of Rosemarie Morbelli with Gabelli & Company. Please go ahead.
Thank you, and good morning, everyone.
Good morning, Rosemarie.
Kevin, you mentioned that it should be difficult to sell the paper business in this environment. Could you touch on the possibility of selling carpets, or did you put the two of them in the same basket?
I think they both have similar characteristics in that, there are not a large number of competitors in that space, so that limits the strategic options. And obviously, there are antitrust implications surrounding that as well. But – so our focus has been, we will continue to listen to ideas and thoughts and discussions that people want to have. But our focus has been improving the performance of our business and taking action on things we can control.
And so what we can control as our capacity, our capacity utilization, the technology we bring to the market, the innovation we bring to the market and the pricing, and the value we capture from what we’re bringing to the market, and that’s what we’ve been focused on and we’re very excited by the team.
We have a new team in place over the last two years in this business that is very much driving those things that are making a difference in terms of positive cash and profit contribution from this business and as we expect to continue to do going forward.
If you put the two of them together, could you share with us the kind of margin they had prior to management changes, where we are today and what is the potential, the optimum profitability level?
Yes, so we don’t reveal profitability of our individual product lines. So we would not do that. But suffice it to say, as we said in our release that we’ve had four consecutive quarters of improvement in our performance materials business overall, which paper and carpet is the biggest part of that.
And so let’s say we went from A to B, can we go to twice B over the next couple of years for example or is that being too optimistic?
Well, we’re going to be very focused on continuing to drive that trend. Let me say that and let me say that we’re also very focused on growing our specialty businesses. As we grow our specialty businesses, our mix improves. So that’s what drives the overall company performance is growing our specialty business faster than the overall company. That’s where our focus is. But at the same time, the performance materials, very focused on margin enhancement and cash generation.
All right, thanks. And I was wondering if you could give us a feel for what is behind the volume recovery in oil and gas, at least, when U.S.?
We’ve worked very hard at diversifying our business. We have – we diversified globally. We’ve diversified customers we’re serving. We’ve diversified some of the markets that we’re serving as well, and so I think that is a big contributor to us, what we believe is outperforming the market from a volume standpoint that we were almost flat – nearly flat as we said in the – so I think all of those things have contributed to and we continue to focus on oil and gas.
As many other players in the industry have cutback resources, we have continued to focus on this business. We take a longer view. We believe the market will recover. We don’t try to forecast exactly when that’s going to be, but we do believe the market will recover. But at the same time we’re making progress without lot of market recovery by globalizing our business and diversifying our business.
Could you touch on the area and I should know that, but I apologize. I don’t, at least, I don’t remember, which areas of the oil and gas are you serving in which – what kind of product line?
Yes, so lot of what we do is for fluid loss control, which is used during the drilling process and it is – at the end of the day, it enhances the productivity of drilling. So while there is not as much expiration going on, what has become a huge focus of the industry is how to be more efficient what they’re doing.
So given our products enhanced productivity of drilling, there is still a strong demand for the need to do that and as we diversify internationally and do markets and so forth. We’re finding new opportunities for growth. It’s very unique technology. It’s very much differentiated and so as we continue to be able to communicate our value proposition to the customers, we’re seeing opportunities for us to do better than market.
Okay, thank you very much.
And Mr. McMullen, we have no further questions in queue.
Okay. Let thank you all for joining us for our second quarter release. And John, if you want to give the replay information, we look forward to talking to you all at the end of our third quarter. If you have any other follow-up questions by all means, please don’t hesitate to contact us.
Thank you. And ladies and gentlemen, a digitized telephone replay is scheduled from June 29, 2016 at 1 PM Eastern until July 19, 2016 at 11:59 PM. Also, an audio replay will be available on the OMNOVA Solutions’ website, which is www.omnova.com until noon Eastern Time on July 19, 2016.
That does conclude your conference for today. Thank you for your participation. You may now disconnect.
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