Zep F1Q08 (Qtr End 11/30/07) Earnings Call Transcript

Jan.10.08 | About: Zep Inc. (ZEP)

Zep Inc. (NYSE:ZEP)

F1Q08 Earnings Call

January 10, 2008, 11:00 amET

Executives

John K. Morgan – Chairman,President and Chief Executive Officer

Mark R. Bachmann – Executive Vice President and ChiefFinancial Officer

Jill Gilmer – Assistant Corporate Secretary

Analysts

John [Emoric] - Ironworks Capital

David [Woodyea] – Keeley Asset Management

Richard Glass – Morgan Stanley

David Beard - Morgens Waterfall

Dennis Delafield - Delafield Asset Management.

Operator

Good morning, and welcome to theZep Inc. conference call. On thecall today will beJohn Morgan, Chairman,President, and Chief Executive Officer; Mark Bachmann, Executive Vice Presidentand Chief Financial Officer; and selected members of senior management. After today’s presentation there will bea question and answersession. (Operator instructions)

Today’s conference call is being recorded. If you have any objections you may disconnectat this time. Now I would like to introduce Jill Gilmer,Assistant Corporate Secretary, you may begin.

Jill Gilmer –Assistant Corporate Secretary

Good morning and thank you for joining Zep today on our 2008first quarter conference call. Here withus are John Morgan, Chairman,President, and CEO; Mark Bachmann, Executive Vice President and CFO; and otherselected Zep officers.

I would like to remind everyone that certain informationincluded in thisconference call may contain forward-looking statements that involve risks,uncertainties, and assumptions. If therisks or uncertainties ever materialize or if theassumptions prove incorrect, our results may differ materially from thoseexpressed or implied by such forward-looking statements.

Allstatements, other than statements of historical fact, could bedeemed forward-looking including but not limited to any projections offinancial information; any statements about historical results that may suggesttrends for our business; any statements of theplanned strategies and objectives of management for future operations; any statementsof expectations or belief regarding future events, potential markets or marketsize, technology developments, or enforceability of our intellectual propertyrights; and any statements of assumptions underlying any of theitems mentioned. For adescription of risks and uncertainties please refer to thecompany’s filings with theSecurities and ExchangeCommission, including its Form10-K and its recently filed 10-Q.

Now I will turn thecall over to John Morgan.

John K. Morgan – Chairman, President and Chief Executive Officer

Thank you, Jill, and to allof our investors and employees welcome to thecall. I will take just amoment to comment on our first quarter results and then I will ask Mark to takeus a little deeperinto a description of thefirst quarter.

For thefirst quarter our net sales were $143.6 million, a$6.7 million, or 4.9% growth over theprevious year’s first quarter revenue of $136.9 million. Our diluted earnings pershare were $0.30 versus thefirst quarter of last year’s diluted earnings pershare which were $0.12. Favorablepricing and a positiveimpact from foreign currency exchangerates were the primarycontributors to theincrease in sales.

Overall, unit volume remained consistent with thefirst quarter of last year driven by increased shipments to our retail andinternational channels, but offset by declines inother areas. For example, during thequarter we did realize some volume decline due to aconscious decision to deemphasize certain lower margin customers, which is partof our long-term strategy to enhance margin growth.

I would characterize our first quarter as one with goodresults, but not yet great results. I amvery pleased with theimprovement when compared to last year and I would remind us allthat our longer term objectives include obtaining margins which exceed thosereported today.

Mark, why don’t you take us alittle deeper into a descriptionof the quarter andthen before we open itup to questions I would like to comment on expectations for thefuture.

Mark R. Bachmann –Executive Vice President and Chief Financial Officer

Thank you and good morning. As you mentioned, John, our overall revenue grew 4.9% and our actualearnings per sharegrew 150% when compared to our earnings pershare in our firstquarter of last year.

Pricing contributed $2.9 million insales growth and foreign exchangerates added another $3.8 million. Ourvolumes were flat. We were pleased withour growth in certainareas including home centers, industrial distribution, international, food, andnational accounts. We arealso pleased with our customers’ response to our new GreenLink products, aline of 82 environmentally sustainable products.

During thequarter, gross profit increased $4.8 million or 6.1% to $83.4 million. Our gross profit margin increased to 58.1%, animprovement of 60 basis points over theprevious year’s first quarter. Ourimproved gross profit was primarily due to thefavorable pricing that supported revenue growth, although itwas partially offset by higher raw material cost. To address this, we have initiated pricingactions of selected products, particularly those affected by adverse trendassociated with energy related commodities. Our sourcing team continually monitors, addresses, and carefully managesour raw materials to minimize thefinancial consequences.

Operating profit dramatically improved during our firstquarter reaching $10.8 million from theprevious year’s $5.2 million. Andoperating profit margins increased 370 basis points to 7.5%. Theoperating profit and margin growth was realized predominantly from pricing andtighter control of our sales related expenses.

During thequarter we reduced our selling, distribution, and administrative expenses by$600,000. Thesavings came from changesin our yearly firstquarter sales meeting format and through improvements related to thehiring of our sale reps, but these improvements were partially offset by ouron-going costs associated with being apublic company.

Our first quarter achieved 158% increase innet income to $6.3 million or $0.30 perdiluted share, versus the$2.4 million or $0.12 perdiluted share reported inthe prior year. Operating profit improvement and adecrease in oureffective tax ratedrove the net incomegrowth.

Our first quarter tax ratewas 35.8% down from 37.7% we realized inthe prior year, whichwas effected by anon-deductable item related to theenvironmental legal charge we incurred last year. Going forward we anticipate our effective taxrate to beapproximately 37%.

Historically we consume cash inthe first quarter ascertain liabilities aretypically paid during this period of each fiscal year. This year due to our increased profits weconsumed only $6.8 million incash, which was $3.3 million less than theprior year. Our working capitalmanagement continued to make progress reducing our net trade cycle by two days.

While we arepleased with our first quarter numbers, we realize that there is vast room forimprovement and we areusing this fiscal year to transform and position thecompany for better and more profitable growth inthe future. We anticipate inconsistent results as weundertake various restructuring initiatives inorder to streamline and improve our operations, but over thecoming quarters as our strategic initiatives areimplemented we will improve our margins and working capital turns. On along-term basis we will expand our focus to consolidating revenue growth.

John, you wanted to comment on future expectations before wego to questions.

John K. Morgan – Chairman, President and Chief Executive Officer

I do, thank you, Mark. First, I would like to point out that our business does have ahistoric seasonal trend. Thesecond quarter is traditionally our weakest. Our second fiscal half tends to outpace our first fiscal half of theyear. We further expect to seean impact inour second quarter revenues this year as our retail customers undertakeinventory reduction initiatives atthe end of theirfiscal years.

Sowhile I expect our second quarter to continue to beour weakness, I doexpect that our second half will generate greater earnings than our first half. And that is similar to our historicalearnings patterns that areoutlined in our 10-K.

While ithas only been sixweeks since our last conference call, I ampleased to say that wehave made good progress inthe early stages ofimplementing our strategic plans. Inthe past severalmonths, we have sharpened our focus on thekey initiatives tomake this a muchbetter business.

As of October 31, when we became apublic company our role changed. Now we have aggressively begun to pursue andimplement our dynamic profitable growth-driven plans that will produce near andlong term results andsupport a strongfinancial improvement, particularly insales and margins and return on invested capital, thereby creating significantshareholder value.

We have started to utilize thelean implementation tools and as one would expect theresults are firstbeginning to show up inincreased capacity and better service. For example, during thepast ten weeks we haveshift to our largest customers with absolutely record service and productquality. Our Chief Supply ChainOfficer, Cedric Brown, and his team have gotten off to agreat start. Within thenext six months theywill begin implementation of anew plan for our North American supply chainfootprint. I expect itto result in productsbeing made available more rapidly and reliably while reducing logistical cost.

In thenext 60 days, Bill Holl, our Executive Vice President, and Chief CommercialOfficer, and his team will bepresenting their final plan for demand shaping our business. I expect implementation to begin immediatelyand anticipate that from this we will eliminate anumber of unprofitable products as well as discontinue doing business with anumber of low profitcustomers. Bill will also bepresenting a plan toexpand into the $6.4billion industrial distribution channel by establishing anetwork of distributors to serve market segments where we arenot selling today. Our goal is to have10-15% of our total revenues coming from new channels of distribution within thenext three years.

Finally, I continue to bevery pleased with our compliance focus including our environmental complianceand our voluntary remediation. Ourlong-term goals interms of revenue growth, EBIT margins, earnings pershare growth, and return on invested capital were discussed during our November29th 2007 conference call and those remain unchanged. Our strategic initiatives, discussion as wellas our comments on this quarter, arearchived for your convenience on (zepinc.com).

We arevery optimistic about thefuture and we are verypleased with the teamthat we have in placeto transform this business. And now wewould like to take your questions, soKatie if you would open up theline for questions.

Question-and-AnswerSession

Operator

Thank you. (Operatorinstructions) And we take our firstquestion from John [Emoric] with Ironworks Capital.

John K. Morgan – Chairman, President and Chief Executive Officer

Hi, John.

John [Emoric] - IronworksCapital

Hi, how areyou doing?

John K. Morgan – Chairman, President and Chief Executive Officer

Good, thank you.

John [Emoric] - IronworksCapital

Just acouple of clarification questions, the$8 million that you spent over theyear on thetransformation of thebusiness. Would that bein thefiscal year, sotherefore, over thenext three quarters or just over thecalendar year of ’08? I know that’s akind of goofy fine-tuning question but just wondering how…

John K. Morgan – Chairman, President and Chief Executive Officer

That’s fine. John, Ithink that you arereferring to that which we had previously disclosed as arestructuring charge that we would anticipate atsome point in time inthe future. Is that correct?

John [Emoric] - IronworksCapital

I think that’s right.

John K. Morgan – Chairman, President and Chief Executive Officer

Yes, I think that’s right. We have not taken any of restructuring charge inthis first quarter.

John [Emoric] - IronworksCapital

Right.

John K. Morgan – Chairman, President and Chief Executive Officer

We continue to anticipate that we will take arestructuring charge and as we have previously disclosed, I believe, we hadsaid that would be inthe range of, Mark, of$5-8 million? Is that correct?

Mark R. Bachmann –Executive Vice President and Chief Financial Officer

That’s correct.

John K. Morgan – Chairman, President and Chief Executive Officer

And we would anticipate those expenditures, once announcedwould occur over aperiod of time, 12 to 18 months.

John [Emoric] - IronworksCapital

Okay, soyou take the chargeand then the cashexpenditures would beover the 12 to 18months following.

John K. Morgan – Chairman, President and Chief Executive Officer

That’s correct and some may reach out as far as 24, butoverwhelmingly it’s inthat 18 month period.

John [Emoric] - IronworksCapital

Okay, that’s helpful. And then inaddition to above themore recent trends inCAPEX, maybe a $10-15million year? I’m going kind of frommemory here.

John K. Morgan – Chairman, President and Chief Executive Officer

Yes, and again, Mark, correct meif I am wrong. But our sort of let’s say“maintenance level” of CAPEX for this business is between $5 and $6million. We said that we would expectour capital expenditures this year to bein the$11-12 million range. That includes themaintenance levels of CAPEX plus expenditures that we would intend to make (NYSE:A)on SAP financialsystems that we are installing,and also on some things that we think will benecessary in thesupply chain to getsome blending close to customers.

John [Emoric] - IronworksCapital

And then lastly doyou suspect that you will beable to, I know that you aregoing to continue paying it. But willyou be paying thedividend out of free cash flowor after all of theseexpenditures or will you have to borrow alittle bit to do it.

John K. Morgan – Chairman, President and Chief Executive Officer

Mark?

Mark R. Bachmann –Executive Vice President and Chief Financial Officer

We expect to beable to generate free cash flowto pay thedividend.

John [Emoric] - IronworksCapital

Okay. Thank you verymuch.

John K. Morgan – Chairman, President and Chief Executive Officer

Thank you, John.

Operator

(Operator instructions) And we will go next to David [Woodyea], with Keeley Asset Management.

John K. Morgan – Chairman, President and Chief Executive Officer

Hi, David.

David [Woodyea] –Keeley Asset Management

Hi. You made referenceto phasing out some lowprofit customers. Could you give us alittle, or at least aneducated guess as to how much that might affect thesales? And would you comment on whetherthis effort is going to beincreasing in thefuture or whether you have already taken theaction that you think that you need to?

John K. Morgan – Chairman, President and Chief Executive Officer

Theimpact on revenue inour first quarter would, inthat area would have been between $1 and $2 million. And I would saywe are just gettingstarted. I don’t have absolute clarity,frankly, at thedegree to which we’ll benefit from that inthe future. That report out that I referred to earlier,which we call “Demand Shaping” over thenext 60 days will really bring clarity to that.

But clearly we area business that hasa number of productsthat are late intheir product life cycle. And anumber of customers that have come on that aresmall customers buying less important products. And we need to attack that, soI would say that wereally just got started on that.

David [Woodyea] –Keeley Asset Management

Okay if I could just ask aquick question, I know that I don’t have to ask, but I noticed on thepress release adifferent person is mentioned as thecompany contact. Clarify who is really runningInvestor Relations.

Mark R. Bachmann –Executive Vice President and Chief Financial Officer

This is Mark Bachmann. Investor Relations is my responsibility and we have other people who areassisting, Cathy Frost, who is mentioned down there is assisting us inthat effort.

David [Woodyea] –Keeley Asset Management

Okay, thank you very much.

John K. Morgan – Chairman, President and Chief Executive Officer

Thank you, David.

Operator

We will go next to Richard Glass with Morgan Stanley.

John K. Morgan – Chairman, President and Chief Executive Officer

Hi, Richard.

Richard Glass –Morgan Stanley

Hi, guys, nice number here.

John K. Morgan – Chairman, President and Chief Executive Officer

Thank you.

Richard Glass –Morgan Stanley

Agood start, we will call it. Can youguys give us any more insight into what therestructuring charge that $5-8 million that you talked about is goingtowards? And if you can’t really tell uswhat it’s going towards, can you atleast tell us how you look atthe expected paybackperiod or the IRR’sfor those sorts of spending?

John K. Morgan – Chairman, President and Chief Executive Officer

Rich, let’s just assume $8 million since we have set arange of $5-8 million atthis point in time andtalk from that point. Without breaking itdown to each category individually, some of those costs would berelated to the thingsthat we needed to do inthe supply chain. To consolidate some of our operations andtake some operations closer to our customers to reduce logistical cost,increase service and soforth. And that’s agood bit of that.

Other costs inthere would beassociated with theconsolidation of operations inthe Atlanta area. For example, we’ve announced to employeesthat we are going to closethe corporate office atthe Riversidelocation. Myself, and my staff forexample, have in thelast few weeks moved to our Seaboard location where our primary factory islocated, and we areclosing that corporate office. There is animpaired asset of lease there so.

And then thethird thing is there’s some costassociated with thedemand shaping. Soit’s those three primary categories. Ifyou assume those expenditures take place over thenext 12 to 18 months while some items might have apayback of greater than ayear, others I would expect much less than ayear. And sofrankly, I would expect paybacks of year or slightly more on thetotal amount.

Richard Glass –Morgan Stanley

Allright, great, itsounds good. Thanks.

John K. Morgan – Chairman, President and Chief Executive Officer

Thank you.

Operator

Thank you. Our nextquestion will come from David Beard with Morgens Waterfall.

John K. Morgan – Chairman, President and Chief Executive Officer

Hi, David.

David Beard - MorgensWaterfall

Hi, good morning. Most of my questions have been answered but could you just walk methrough your working capital needs just as your operating cash flowis negative in thefirst quarter of ’08, although animprovement from theyear before. Can you just walk methrough the need ofwhere the capitalneeds is coming from? Thanks.

John K. Morgan – Chairman, President and Chief Executive Officer

I’m going to ask Mark to take us through that which is apretty inconsistent pattern as thefiscal year goes on. So, Mark, maybe youcould take us through that?

Mark R. Bachmann –Executive Vice President and Chief Financial Officer

Yes, I will. Clearlythere with roughly 53% of our revenue inthe second half of theyear you’ll see abuilding and some seasonality relative to thereceivables moving, obviously with therevenue over thecourse of the year.

Inventories have, historically, built over the, interms of days on hand of inventory, they tend to build up over thefirst four or five months and then decline for therest of the year. Sothat is pretty much our historic patterns.

John K. Morgan – Chairman, President and Chief Executive Officer

I would say, David, and again I apologize I don’t haveabsolute clarity on this. But it’s beenmy experience that as we undertake demand shaping and become more aggressive atthat, and of course our lean initiatives. One of thethings that I would, frankly, expect to seeis us able to changeour pattern of working capital demands on thebusiness and see thedemand to come down as time goes on. Andso, I’m confident that when we arehaving this conference call for our second quarter inApril that we will talk alot more about what our expectations arethere.

David Beard - MorgensWaterfall

Okay, good, thank you.

Operator

Thank you. (Operatorinstructions) We will take our nextquestion from Dennis Delafield with Delafield Asset Management.

John K. Morgan – Chairman, President and Chief Executive Officer

Good morning, Dennis.

Dennis Delafield -Delafield Asset Management

Good morning, John. Would you just, I just came inand I don’t have any specs or anything infront of me. Would you remind meof how much the secondquarter normally seasonally drops off and can you give meany indication of how much theprofitability would drop off. Would youexpect to dip into thered or what we might expect?

Mark R. Bachmann –Executive Vice President and Chief Financial Officer

Dennis, this is Mark. If you look over thelast two years that were inthe 10-K, anywhere between7 and 10 or sopercentage of thetotal year’s net income is derived inthe secondquarter. And low20% kinds of percentage of revenue inthat quarter.

Dennis Delafield -Delafield Asset Management

20% of revenue inthat quarter?

Mark R. Bachmann –Executive Vice President and Chief Financial Officer

Yes.

Dennis Delafield -Delafield Asset Management

Okay, that should help. I’ve got all ofmy sheets close in theroom. I just wanted to speak. And you areexpecting that this year to follow that normal pattern.

Mark R. Bachmann –Executive Vice President and Chief Financial Officer

We arenot giving quarterly guidance. Dennis,what we are saying iswe expect and what we aretrying to communicate to folks who may not have tracked that or knows that on astand-alone basis, we dohave the seasonalpattern and so we arejust making people aware of what our seasonal patterns have historicallybeen. But we arenot giving specific guidance as to what this second or third quarters will be.

John K. Morgan – Chairman, President and Chief Executive Officer

Dennis, you have watched Zep for quite some time and itwould probably beuseful to pull those patterns from that 10-K, and we expect those to besimilar.

Now, let’s doremind everybody that allof our discussion there is net of anything we might dorelative to restructuring charge we aretrying to firm up atthis point in time.

Dennis Delafield -Delafield Asset Management

Of course, good, thank you.

John K. Morgan – Chairman, President and Chief Executive Officer

Thank you, Dennis.

Operator

Thank you. We willtake a follow-upquestion from John [Emoric] with Ironworks Capital.

John K. Morgan – Chairman, President and Chief Executive Officer

John?

John [Emoric] -Ironworks Capital

Yes, thanks. Theshare count was alittle lower than I had inmy model. I don’t know what thegrowth is going to be justfrom options plans growing. And I knowthat you have got thenew plans as any new company would. Anything that you can tell us about on thesequential or theaverage share count for theyear that I might want to put inmy model? Relative to what we justshowed, say inNovember?

Mark R. Bachmann –Executive Vice President and Chief Financial Officer

John, it’s Mark, probably one of thereasons that it’s abit lower than what people might have anticipated was that prior to thedistribution, Acuity Brands was repurchasing shares as they announced intheir earnings call earlier this week. We did have some options grants that we have disclosed inthe first quarter andthere weren’t as many grants that were transferred from Acuity Brands. And so, but interms of giving you guidance for thenumber of shares…

John [Emoric] -Ironworks Capital

I guess that net and number of shares, you wouldn’t expectthat to materially changein thenear future.

Mark R. Bachmann –Executive Vice President and Chief Financial Officer

No.

John K. Morgan – Chairman, President and Chief Executive Officer

Yes, thegrants areincorporated in thisnumber that we saw today.

John [Emoric] -Ironworks Capital

Oh, yes, okay, great. Thanks.

John K. Morgan – Chairman, President and Chief Executive Officer

Okay.

Operator

Thank you. And withno further questions inthe queue I would liketo turn the conferenceback to Mr. John Morgan for any additional or closing comments.

John K. Morgan – Chairman, President and Chief Executive Officer

Thank you, Katie, and thank you everybody for taking thetime to dial in. We look forward tospeaking with you inApril. Have agood day.

Operator

This concludes today’s conference. We thank you for your participation. You may now disconnect.

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