General Cable (BGC) Mike McDonnell on Q2 2016 Results - Earnings Call Transcript

| About: General Cable (BGC)

General Cable Corporation (NYSE:BGC)

Q2 2016 Earnings Conference Call

August 04, 2016, 08:30 AM ET

Executives

Len Texter - SVP, Finance IR

Mike McDonnell - President & CEO

Brian Robinson - CFO & EVP

Analysts

Brent Thielman - D.A. Davidson & Co.

Shawn Harrison - Longbow Research

Operator

Good morning. My name is Jack and I will be your conference facilitator.

I would like to welcome everyone to the General Cable Corporation Second Quarter 2016 Earnings Conference Call. This conference call is being recorded at the request of General Cable. Should you have any objections, you may disconnect at this time.

All participants have been placed on mute to prevent any background noise. There will be a question-and-answer period after the speakers' remarks. [Operator Instructions] Thank you. General Cable, you may begin your conference.

Len Texter

Good morning, everyone, and welcome to General Cable's second quarter 2016 earnings conference call. I am Len Texter, Senior Vice President, Finance and Investor Relations. Joining me this morning are Mike McDonnell, our President and Chief Executive Officer, and Brian Robinson, our Chief Financial Officer.

Today's call will be accompanied by a slide presentation, which is available on our website at generalcable.com. If you have not downloaded a copy, we recommend that you do so as we will refer to the presentation throughout our prepared remarks.

On today's call, Mike will provide an overview of our progress on our strategic roadmap, our second quarter performance, and third quarter outlook.

Before we get started, I wanted to call your attention to our Safe Harbor provision regarding forward-looking statements and company-defined non-GAAP financial measures, as defined on Slide Number 2, as we will be making forward-looking statements and referring to adjusted results in today's call. To begin, please turn to Slide Number 5.

I will now turn the call over to Mike McDonnell. Mike?

Mike McDonnell

Thanks, Len. Good morning, everyone, and thank you for joining us on the call today.

We are pleased with the strong performance in the quarter that reflects the results of our focused execution and the significant operational improvements that we've made in the company.

We delivered on our operating performance targets, despite a topline, which was burdened by an uneven and choppy end market demand environment. We also continued to simplify and focus our portfolio through the sale of three businesses and applied the proceeds toward reducing leverage on our balance sheet.

While early in the implementation phase, we've already generated momentum in all of the key initiatives of our strategic roadmap that we believe will unleash our competitive advantages, enabling us to compete more effectively and allowing us to deliver significant value to shareholders over the coming years.

Our strategic roadmap is designed to help us to become the best-performing company in the industry in the markets we choose to serve by capitalizing on scale, leading market positions, innovative capabilities, efficient cost structure, and a vibrant high-performance culture. Some of these things we already have and some we are developing.

Our roadmap is a comprehensive plan that allows us to capitalize on our strengths as we pivot to become a focused, efficient, and innovative company with substantial operating scale.

As you'll remember, our roadmap has four key elements. First, we are working to focus and optimize our portfolio based on the criteria of market leadership, operating scale, ability to attain an industry-leading cost structure, and long-term sustainable growth potential.

We are focused on our electric utility, industrial, and communications businesses and we are investing the appropriate resources to drive these businesses to their full potential. We have also taken many steps so far to exit businesses that we don't believe can meet our criteria over time. These asset sales have the added benefit of reducing our balance sheet leverage.

The second element of our roadmap is to develop an industry-leading cost and efficiency position through initiatives to consolidate and streamline our manufacturing operations and to drive supply chain efficiencies. This is an area of tremendous activity right now and for the next 18 months. For example, in our manufacturing operations nearly half of our plants worldwide are undergoing substantive project-driven change.

At the end of this part of our journey, our goal is to have focused, efficient factories, an optimized supply chain, and substantial competitive advantage from an industry-leading cost position. These efforts are proceeding well.

The third element is targeted, sustainable, profitable growth through product and service innovation and other competitive advantages. We are very busy right now building a -- with a series of projects that should provide all the capabilities we need in order to outpace market growth. Our customers are already starting to see improvement from our early work in this area.

And finally, the fourth element is to cultivate a high-performance culture. In my view, culture is arguably the most important component of our roadmap. It defines how we act and interact to create business success.

Our global team has a clear vision and sense of purpose, a roadmap to follow that they believe in and are aligned with, and a common set of values and behaviors that they all participated in creating.

Culture is a long journey, but I am so pleased to see early improvements in our engagement and Net Promoter metrics, which we measure monthly through Pulse surveys. I also see the improvement in all kinds of informal ways during my travels within the Company and in particular out with our customers.

When I described this roadmap at our investor day, I emphasized that while our three-year targets are ambitious, and they should be, we believe that we have the initiatives and teams in place to achieve them.

Now I know that our investors are interested in getting more insight into how and when the results will phase in over time. While we are not ready to provide quantitative guidance on the phase-in of the financial improvements over the next three years, I can at least provide some limited color on impact timing of various parts of the roadmap.

Now early on in the transformation, before any of the key initiatives are completed, we expect to see benefits just from overall improved execution as our organization gets more energized, more focused, more accountable.

These early improvements are really hard to forecast, but they are real, and we are beginning to see them in the execution in the last few quarters. I can feel the energy when I come to work every day and there is a real momentum internally around what we are trying to achieve.

Now a portion certain of the roadmap initiatives will start to impact sooner than others. We expect earlier impacts from initiatives, such as global procurement, the acceleration of our lean Sigma programs, and some of our share recovery initiatives. And we expect them to begin phasing in late this year and be full strength by mid-2017.

The other portion of our initiatives are substantial 12 to 18 month projects. We expect these initiatives to phase in late 2017 and be fully in place during 2018.

At that time, we expect to see the full results and benefits that we outlined at our investor day, including improving adjusted operating income by $160 million, improving adjusted operating margin to more than 7%, delivering return on invested capital of more than 12%, bringing the net leverage ratio to below 3 times, and generating cumulative free cash flow in the range of $400 million, while continuing to support the annual dividend.

The momentum we have gained so far in advancing our roadmap initiatives this quarter has been really encouraging, and we will stay relentlessly focused on completing these initiatives and bringing the benefits into the financial results over time.

Next, I want to provide you with an update on some of the achievements we made with respect to our portfolio optimization and simplification initiatives and our July 2014 restructuring program. As you know, we are simplifying our portfolio so we can focus on bringing our strongest businesses to full potential.

To that end, we completed the sale of three businesses including our North American automotive ignition wire business, as well as the sale of our operations in Venezuela and in Egypt. Collectively, we generated more than $83 million of proceeds from these divestitures, which we applied toward reducing our outstanding borrowings.

I am also pleased with the execution and continued positive momentum we have achieved since announcing our 2014 Asia-Pacific and Africa divestiture program. We continue to target cash proceeds in the range of $250 million to $300 million. So far, we have generated $193 million of cash proceeds, including the sale of Egypt in the second quarter 2016.

We are managing an active process and pressing forward with the divestitures of the remaining operations in Africa, including Algeria, Angola, and Zambia, and Asia-Pacific, including China and New Zealand. As we communicated earlier this year, we signed a contract for the sale of our operations in Zambia and are working toward completing that transaction in the second half of 2016.

On our July 2014 restructuring program, we generated $9 million of incremental savings and we remain on track with our restructuring savings target of $80 million to $100 million.

Next, I want to touch base on two very important matters before moving on to provide some color on our second-quarter results and outlook. First, I am pleased to announce that the Board of Directors has named Chris Kreidler to serve as Interim Chief Executive Officer effective August 15, 2016. Chris will replace Brian, who, as communicated in March 2016, is leaving the Company to pursue other interests.

On behalf of the Company and personally, I want to thank Brian for his many, many contributions over 17 years. I really believe that many of the strengths that we have today are due in no small measure to the leadership that Brian has shown in this Company for 17 years, and he will be missed.

And Brian, I wish you congratulations and success as you move on to your new position in your new company.

Brian Robinson

Thank you, Mike.

Mike McDonnell

The company's search, with the assistance of Heidrick & Struggles, for a permanent replacement CFO is advancing very well, and we are seeing a good flow of highly qualified candidates.

Chris most recently served as Executive Vice President and CFO at Sysco Corporation, and during his 28-year career, he also held numerous leadership roles across Yum! Brands and C&S Wholesale Grocers. Chris brings decades of experience in supporting companies with global operations, as well as a distinctive leadership capacity to manage teams and apply financial expertise to business management. We are confident that he will be a strong asset to the Company as we conclude our active search for a permanent CFO.

Second, I would like to provide an update on our ongoing internal FCPA-related investigations in Angola, Thailand, India, China, and Egypt. As we previously communicated, we substantially completed our internal review in these countries as of year-end 2015.

Since that time, we have been in frequent communication with the SEC and DOJ regarding the findings of our internal investigation, and I am pleased to report that we are now in the early stages of discussing a potential resolution of these matters with the SEC and DOJ.

Based on these discussions, we presently believe the amount of total probable disgorgement of profits, including prejudgment interest, required to resolve the investigation is in the range of $33 million to $59 million. As a result, we have increased our existing accrual as of July 1, 2016, by $5 million to $33 million, which represents the low end of this range.

The amount accrued solely reflects profits and prejudgment interest that may be disgorged and does not include, and we're not able to reasonably estimate, the amount of any possible fines, civil or criminal penalties, or other relief that may be assessed or acquired in connection with any potential resolution with the SEC or DOJ.

We look forward to continuing our progress toward an acceptable resolution with the government and bringing this matter to a close.

Next, on our second-quarter performance, on Slide 12, overall we delivered another solid performance in the second quarter, despite the continuing challenging operating environment. We generated adjusted operating income at the top end of our guidance range, excluding the unfavorable metal price impact in the quarter relative to guidance assumptions.

And just to remind you again about the metal price impacts, recall that metals are typically a pass-through cost, but we are affected in approximately half of our business by changes in metal price between the time we buy the metal and the time we sell the cable made with the metal, which typically can average around three months.

So when metals are declining, there is a temporary, typically one quarter, unfavorable impact on EBIT and a corresponding favorable impact on cash flow as we replenish metal stock at the lower metal price.

We believe that identifying the metal price impact gives more transparency on the underlying performance of the business. It also illustrates the resilience of our business model to commodity price fluctuations. Recall, also, that our margins are not correlated with metal price levels, as we discussed previously and in depth at our investor day.

Adjusted operating income was up $7 million or 17%, as compared to the first quarter, which shows we're heading in the right direction and focused on performance improvement and operational execution. In fact, it is interesting.

If you set aside the impact of the previously communicated and anticipated headwinds related to our subsea project business, which is transitioning off a significant multiyear project, that's Baltic 2, and the ongoing market challenges experienced in our specialty cable business, particularly oil and gas, adjusted operating income would have improved more than 50% versus the first quarter.

Year-over-year adjusted operating income for the second quarter was down $6 million, but again, setting aside the easing of subsea project activity and oil and gas, our results for the second quarter of 2016 would have been up 5% as compared to the second quarter of 2015.

So, clearly, our focused execution and operational improvements are materializing, which is significant, given the relatively weak and choppy end-market demand environment that we are all experiencing.

Overall, unit volume increased 3% sequentially. This increase principally reflects seasonal demand in Latin America and demand for electric utility cables in Europe, specifically the land-based turnkey projects.

In North America, despite being below our seasonal expectations for the second quarter, we were pleased with the momentum of our electric utility business, and the distribution piece of that in particular, and our construction business in nonresidential construction, which are up nicely sequentially and year over year.

Renewables, grid hardening, and nonresidential construction continue to drive demand for these products and the segments were up 1% and 3%, respectively, versus the first quarter and up 10% and 9%, respectively, versus the second quarter of 2015, so clearly strength there.

Another bright spot has been our data communications business, driven by the need for greater connectivity and the development of data centers, which increased 4% sequentially in the second quarter of 2016.

On the other hand, areas where we are experiencing some demand pressure include our industrial and specialty businesses. Specifically, we continue to experience lackluster demand in oil and gas, which seems to be bottom searching as we move into the second half now.

As a reminder, our plan is not contingent on robust market assumptions. We anticipated this uneven and low-growth demand environment in our three-year strategic roadmap. In fact, I am encouraged by the relative demand strength of our electric utility distribution and construction businesses, which were together up mid-single digits year over year for the first half of 2016.

Let's turn to Europe. In Europe, unit volume improved 7% sequentially, driven by electric utility and energy cable demand. We continue to experience solid end-market demand for electric utility cables, including land-based turnkey projects, and these are driven by the advancing grid interconnection projects in Europe, which remain on track and are in the plan for many years.

In our subsea turnkey project business, tender activity remains stable and we continue to secure projects. Our backlog as of the end of the second quarter for subsea and land-based turnkey projects was $225 million, and that was up from the $160 million reported at the end of the first quarter. That's very positive.

As we have communicated specifically relative to our subsea turnkey business, we are in a period of transition between projects and production activity as we finalize the multi-year Baltic 2 project. This business is expected to trough over the second half as we complete this transition and ramp up production on some of our new projects.

Lastly, our communication business in Europe is also growing nicely as we leverage our newly installed fiber capacity.

Now turning to Latin America, unit volume for the second quarter improved 16% versus the first quarter of 2016. Half of this improvement was driven by the shipment of aerial transmission cables in Brazil and the other half was driven by broad-based seasonal demand improvement coming off the typically weak first quarter.

Excluding aerial transmission cables in Brazil, demand declined 1% year over year as construction spending remains uneven throughout the region, driven by low growth rates, volatile currencies, and low commodity prices. But I think we have a very stable region here.

As summarized on slide 17, net debt for the second quarter of $961 million was down $27 million from the end of 2015 and down $99 million from the end of the first quarter. As mentioned, we applied divestiture proceeds to reduce our outstanding borrowings.

We also generated operating cash flow from continuing operations of $49 million in the second quarter through tight management of working capital, including inventory levels, as well as the collection of receivables on our subsea turnkey projects. Again, good news.

We currently have $383 million of availability under our North American and European based credit facility. In addition, we have approximately $40 million of availability on working capital lines and cash in our Latin American businesses. We are well positioned to fund the business, including working capital requirements, restructuring and roadmap activities, and the quarterly dividend.

As you'll recall from our investor day, we outlined $125 million of capital spending over the life of the three-year program to fund the various initiatives. As mentioned earlier, our strategic initiatives are underway and, as a result, our capital budget for 2016 is expected to be in the range of $100 million.

This budget includes $50 million of maintenance CapEx spending and $50 million of spending on roadmap initiatives in the year. We expect the remaining $75 million of the $125 million of capital spending to come in 2017.

With respect to our third-quarter guidance, we are encouraged by the demand trends in our electric utility distribution and nonresidential construction markets, which have been up mid-single digits year over year so far this year. And we still expect certain end-market demand to be uneven, mainly in our industrial and specialty markets, particularly oil and gas.

We also expect the normal seasonal slowing in our European businesses, and that we see every year, and further easing of our subsea turnkey project business, as previously discussed and anticipated.

Our third-quarter outlook for adjusted operating income of $35 million to $50 million also reflects at the midpoint a very conservative view of end-market demand.

Finally, I want to reiterate that we've built our strategic roadmap in anticipation of a weak and uneven demand environment, precisely like the one we are navigating now.

Overall, I am very pleased with our progress on all of our strategic roadmap initiatives -- portfolio optimization, development of a leading cost position, targeted growth, and highly engaged culture. Every initiative is on track.

We have line of sight to our goals of 7% adjusted operating margin and 12% return on invested capital. Our goal for adjusted operating income of $160 million of improvement over three years is backed by very clear initiatives. Our roadmap is self-funded from current cash flows and we intend to reduce our outstanding borrowings further, while continuing to support the annual dividend.

I want to be very clear that, although our targets are ambitious, I very strongly believe they are realistic and achievable and the initiatives to achieve them are within our control.

Let me wrap up by recognizing and thanking the entire General Cable team for their hard work and strong execution in the quarter. Every day, I see examples of their extraordinary accomplishments, large and small. I'm inspired by their passion to win.

That concludes our prepared remarks. I will now turn the call back over to the operator, who will assist us in taking your questions.

Question-and-Answer Session

Operator

Your first question comes from the line of Brent Thielman with D.A. Davidson. Your line is open.

Brent Thielman

Thank you. Good morning.

Mike McDonnell

Good morning.

Brent Thielman

Get the first question on the FCPA out of the way, just wondering why you have chosen to accrue to the lower end of the range you mentioned versus kitchen-sinking it, if you will, and take the full potential accrual today?

Mike McDonnell

Because that's really -- in terms of the range, that is where we need to be and that's where we believe our position at this time in the discussions is centered around that.

Brent Thielman

Okay. Fair enough. And I guess just turning to the North America margins, I think absent the metal price impact, you likely would have had some improvement there. I guess, first question, is that accurate?

And then, second question, can you piece apart some of the impacts there, considering the sale of the ignition business versus internal initiatives that are helping your margins? I am assuming that ignition wire business was below the segment's average levels.

Mike McDonnell

It was -- the ignition wire business was probably at or slightly above the segment average levels, and that's out of the way now.

In terms of metal impact, we didn't really see a metal impact in the second quarter relative to prior year or previous quarter. That metal impact was only relative to our guidance assumptions, and so, actually, when you look at guidance, we had a $4 million impact relative to the guidance assumptions, negative in the actuals, and so that is how I see that we on an underlying basis outperformed.

There is a lot of activity going on in North America right now. I'm very encouraged by what I continue to see is a strong utility environment in our projects, and our capacity to reach those markets directly and through our distributors continue to be very strong. In particular, the distribution part of that and also in terms of the renewables element of that market continue to be very, very strong, and we participate in that very well. So, that is certainly helping us.

The other area where we continue to see great strength is the nonresidential construction market, which I think is even -- been better than we even thought it would be as we went into this year, and so we are enjoying that as well.

The business around some of the specialty markets, in particular oil and gas, marine, et cetera, that is old news, and I think that has been -- it has been a year-over-year headwind for us, but I think we're at a relatively stable level now. I think it is finding the bottom. And for the second half, I don't really see a negative year-over-year impact from that. I think we have made it past those high points of last year.

And then, the industrial business is the one that is still a question. We think it is flat, possibly slightly down, in the third quarter as we move toward that.

So that's a quick picture of North America. A lot of things going on. A lot of good execution by the company, but our roadmap initiatives have yet to make a material impact here. That's very encouraging. I want to point that out, too. So, I think it was a good quarter from that standpoint.

Brent Thielman

Okay. Okay. And then, taking a step back and looking at the demand environment overall across the company, I know there is a lot of moving parts here, but as you look at it, is the environment for you today any better or any worse than where you feel like the year started?

Mike McDonnell

I think in some areas it is actually better. I think when we look at across the world our utility businesses -- in Europe, I mentioned the grid interconnection work and those are turnkey projects for us, so they are more profitable, bigger projects. And the kind of things that are happening in the utility distribution side in North America and in renewables are very strong.

I think probably at the beginning of the year I was thinking those might weaken a bit, and I have been pleasantly surprised by where we are at with those, and those continue to be strong.

On the transmission of utility side, that is lumpy business. We had a strong first half last year with one project in particular and that can skew it a little bit. I think it is a little bit soft this year, maybe down a couple percent, that segment of utility, transmission, as we look at it versus prior year in the marketplace. But overall, utility is up when we look at those three components that I just mentioned. So, that's positive and I think -- I'm feeling more positive about that.

I've also feeling more positive about nonresidential construction. I spent a lot of time with our customers and some end-user contractors and so forth in the last quarter, and there is some optimism that continues there, that there is a fundamental strength in the US economy, and in particular, nonresidential construction will continue to benefit from that.

Oil and gas is old news. I think it is what it is, so that's pretty much where we thought it would be. And industrial is a little softer, I think, than we would like it to be, but there is still projects and activity out there. It is more spotty; it is more choppy. I think in that market in particular what we are seeing -- as I talk to our customers, they are seeing it -- is quarter-to-quarter variability, but overall I think when we put the whole year together, it is going to be maybe flat to slightly up from last year. Does that help?

Brent Thielman

That is. Thank you. I will turn it over.

Mike McDonnell

Great.

Operator

Your next question comes from the line of Shawn Harrison with Longbow Research. Your line is open.

Shawn Harrison

Hi. Good morning, everybody.

Mike McDonnell

Hey Shawn.

Shawn Harrison

Hi Mike. The increase in the CapEx expectations for this year and next year, you will be running 2X in terms of percentage of sales spending that you have done over the past couple years, and understanding the roadmap. But maybe if you could talk about two things.

Number one, how much revenue capacity that is bringing online as you finish the program in 2017. And then, second, I guess free cash flow expectations for this year, given the higher CapEx. I think right now you are slightly below breakeven in terms of free cash flow for the second half, but understanding cash flow is typically generation weighted to the second half of the year.

Mike McDonnell

Shawn, I will take the first question there around the CapEx spend. The majority of the CapEx spend is aimed at cost reduction and improving our cost position. So, I'm not associating revenue with a return on those projects because very clearly they are reducing our costs and on a structural basis. So those are very sound projects, very good returns, and will position the Company for the long term. These are things that we need to be doing now, and in some cases we should have done earlier. So, we are doing it now.

There is some portion of it that is increasing capacity. You might know I mentioned some of the fiber capacity and so forth. I think we're also, as we look at the communications market overall, we want to be sure we want to keep up with that, that increased demand through greater connectivity and so forth.

So there is revenue associated with that. We really haven't broken that out yet. We might give some guidance on that when those projects get up and running.

Brian Robinson

Good morning, Shawn. It's Brian. On the free cash flow question, just to put it in context, last year the Company did free cash flow of about $200 million before the dividend, and as the Company has talked about 2016, I would say right now I would range it somewhere maybe in the $100 million to $150 million range.

Most of the items, like taxes and interest, are slightly better than 2015, and as you just questioned, CapEx is higher for the reasons mentioned and the working capital benefit last year was about $100 million. And we have been talking about or targeting doing about half of that amount in 2016.

So putting all that together, it is about -- there is some variability here, but call it $100 million to $150 million.

Shawn Harrison

Okay, that's extremely helpful, Brian. In terms of the FCPA investigation, is the expectation that you will see a resolution by the end of the year? Or the discussion is progressing now that we could have an answer before that?

Mike McDonnell

I think the positive is that we are now in those discussions, and we are early in those discussions and I can't comment on the timing, mainly because I don't have anything to say at this point about it. When we get to the end point, and we will, we will happily let you know.

Shawn Harrison

That's very fair. Then, lastly, Brian, just a modeling question on taxes. It has been high in the first half. The tax rate expectation for the back half of the year, please?

Brian Robinson

Yes, I would continue to assume about 50% on the effective tax rate and 25% to 30% on a cash tax rate basis.

Shawn Harrison

Okay, thanks again, and thanks for all the help over the years, Brian. All my best on whatever lies ahead for you.

Brian Robinson

Okay, thanks, Shawn. It's been a pleasure. I appreciate that.

Operator

There is no further questions at this time. I'll turn the call back over to General Cable.

Len Texter

Thanks for joining us this morning. That concludes our conference call. A replay of this call will be available on our website later today. We appreciate your continued interest in General Cable. Thank you.

Operator

This concludes today's conference call. All participants may now disconnect.

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