Nexeo Solutions' (NXEO) CEO David Bradley on Q1 2017 Results - Earnings Call Transcript

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Nexeo Solutions, Inc. (NASDAQ:NXEO) Q1 2017 Results Earnings Conference Call February 9, 2017 10:00 AM ET

Executives

Michael Everett – Vice President and Treasurer

David Bradley – President and Chief Executive Officer

Ross Crane – Executive Vice President and Chief Financial Officer

Analysts

James Sheehan – SunTrust Robinson Humphrey

Ian Bennett – Bank of America Merrill Lynch

Andrew Buscaglia – Credit Suisse

Karen Lau – Deutsche Bank

Operator

Hello and welcome to today's webcast. My name is Catherine, and I will be your web event specialist today. [Operator Instructions]

It is now my pleasure to turn the webcast over to Michael Everett, Vice President, Investor Relations and Treasurer for Nexeo Solutions. Mr. Everett, the line is yours.

Michael Everett

Thank you. Good morning, everyone, and welcome to Nexeo's first fiscal quarter fiscal year 2017 corporate update. With me today are David Bradley, Chief Executive Officer, and Ross Crane, Chief Financial Officer.

Yesterday afternoon, we released our financial results on our fiscal first quarter for the period ended December 31, 2016, including the supplemental slide presentation to accompany this morning's conference call. Both of these items can also be found on our website under the Investor Relations tab at nexeosolutions.com.

For today's call, Dave will begin by providing a brief overview of our operations for the quarter and Ross will then touch on the key financial results. Immediately after prepared remarks, we will open the line for Q&A.

As a reminder, this conference call and webcast presentation may contain forward-looking statements, including statements addressing future financial and operating results of Nexeo and are based on management's current expectations. Actual results may vary materially from the expectations contained in the forward-looking statements. More information about the factors that could cause results to vary from those expressed in the forward-looking statements is set forth in the Company's filings with the SEC.

In addition to disclosing financial results that are determined in accordance with Generally Accepted Accounting Principles or GAAP, the Company also provides certain non-GAAP financial measures. Management believes that providing this additional information is useful to investors to allow them to better assess and understand the operating performance and trends of the business. Reconciliations of these non-GAAP financial measures to the most comparable GAAP financial measures can be found in the appendix at the end of these slides.

With that, I will turn the call over to David for his opening comments.

David Bradley

Thank you, Michael, and good morning, everyone. The first quarter ended in line with our expectations with reported adjusted EBITDA of $34 million. This was down 14% year-over-year and it's slightly better than expectations we outlined in our last call. Also as we expected, the pricing environment that we experienced throughout most of fiscal 2016 persisted well into the first quarter of fiscal 2017. However, consistent with our forecast, we did see positive pricing volatility. We also saw encouraging signs with volume, which increased slightly year-over-year and volume per day showed improve momentum throughout the quarter.

Another headwind we faced during the quarter was supply situation we mentioned on our last call with one of our key plastic suppliers, we launched in SAP implementation in October. The expectation was for a three week period to return to normal delivery levels. The supplier continues to have challenges, which is affecting their ability to ship product, resulting in a significant order backlog for us at the end of the quarter. We continue to work closely with the suppliers and affected customer, but we feel that the impact of this issue will again be seen in our second fiscal quarter.

We continue to execute on controllable items, especially our productivity initiatives. In early December, we completed the implementation of a transportation management system, which improves our costs and service level to our customers. We have started to realize the benefits of this system sooner than we anticipated, accelerating our projected cost savings for this year. We will realize these cost savings by excluding route optimization in-house, including prioritizing shipments on our private fleet, which are about half the cost of common peers and provide customers with substantially better service levels.

We also continue to focus on managing our cost structure. After the initial restructuring of our executive team, we are in the process of further streamlining the related back office functions. We also have several key supplier authorizations so far this fiscal year. We reached agreement with Solvay to take on exclusive distribution of their Rhodoline Defoamer product line. We expanded our national partnership with Silberline for their aluminum and roofing pigments. We expanded our partnership with Wanhua Chemical in the Northeast and Mid-Atlantic in the case end-market and we receive exclusive authorization from Colonial Chemical to represent their products in the personal care end-market in the Northeast.

All of these new authorizations fit square with our strategy of increasing specialty mix with new suppliers and line-card extensions.

I will now turn the call over to Ross to take you through the quarterly numbers in a little more detail and then I will return to provide you a brief outlook for the second fiscal quarter and included a few of my closing comment. Ross?

Ross Crane

Thanks, David. Good morning. For this quarter for the first time in a couple of quarters, the year-over-year comparisons are clean, even though the filed financial statements indicated predecessor and successor period. Total revenue for the first quarter was down 4% compared to last year or $795 million versus $828 million, about 1% of its variance is foreign exchange related. Market conditions and demand in pricing didn't change much from the fourth fiscal quarter of 2016, although the worse and encouraging signs in volume near the end of the quarter.

Lower average selling prices drove most of the revenue decrease. Across the business selling prices were down 5% in both chemicals and plastics. The one exception to average selling price declines was China, which saw price increases of nearly 23% driven largely by product mix in our chemicals line of business there. Overall volume was up slightly year-over-year for the quarter driven by a 4% increase in plastics with strong performance in Asia overcoming lower volume in EMEA and flat volume in North America.

As we mentioned earlier, plastics volume includes the impact from the issue of one of our major suppliers, which will impact the current quarter as well. Chemicals volume declined 2% for the quarter and was fairly broad based across product families and end-markets.

Total gross profit for the quarter was down 11% year-over-year, again pricing was the major driver behind the decline. Also affecting gross profit was the higher depreciation expense resulting from the asset step-ups after the merger in June. Excluding the asset step-ups, gross profit was down 9% for the quarter. The gross profit decline was similar in both chemicals and plastics, but the percentage decline was higher in plastics due to a more pronounced impact of average selling prices on unit gross margins in that business. This also contributed to a greater decline in gross profit margins in plastics.

Total SG&A expense during the quarter was $75 million, which was essentially flat versus the prior year. Included in SG&A was the impact of additional depreciation and amortization of expense of $1 million. From the business combination, approximately $2 million related to severance as a result of restructuring the executive team, and $1 million of increased stock based compensation expense year-over-year. Excluding these items, SG&A was down nearly 6% year-over-year, additionally there was a minor decline in transaction related costs during the quarter.

Net income for the quarter was a loss of $8 million, for a loss per share of $0.11. This includes a non-cash charge of $11 million related to the change in fair value of the deferred consideration. This item is going to fluctuate every quarter as long as the deferred consideration items exits. You will recall last quarter it was a $9 million gain in GAAP earnings, which was a swing of $20 million between this quarter and last quarter or approximately $0.26 per share on the current base of 76.7 million shares.

Adjusted EBITDA for the quarter was $34 million versus $39 million for the same period last year. The largest adjustment to EBITDA this quarter is the $11 million non-cash charge, related to the change in fair value of deferred consideration I just discussed. The other significant adjustments relate to the severance and other expenses for the restructuring of the executive team, which again was about $2 million and the non-cash stock based compensation which was a little over $1 million for the quarter.

We currently have approximately 89.3 million total shares outstanding, inclusive of 12.5 million founder shares. The founder shares are not included in our basic or diluted shares for EPS calculations, because the vesting requirements for such shares have not been met. The $50 million warrants that are potentially exchangeable in the common stock are still out of the money and also are not included in the basic or diluted earnings per share calculations. So, the weighted average shares used in EPS calculation for the quarter was 76.7 million.

We have total debt of about $831 million and net debt of approximately $798 million at the end of the quarter. Both gross debt and net debt are down slightly year-over-year as we continue to generate pretty strong cash flow. Net leverage at the end of the quarter was 4.7 times, which is slightly above 4.4 times from the year ago.

Our objective is still use free cash flow to pay down debt and reduce leverage or pursue accretive acquisitions. Our target leverage range remains between 3.5 times and 4.5 times and will fluctuate depending on the successful closing of bolt-on acquisitions in the future.

Working capital was $474 million at the end of the quarter, which was lower by $12 million year-over-year. At the end of the first quarter, total liquidity was approximately $256 million, consisting of $33 million of cash on hand and $223 million of borrowing capacity under our revolving facility.

Depreciation and amortization expense for the quarter was $17 million. Cash taxes paid during the quarter were approximately $1 million, and cash interest paid during the quarter was nearly $11 million. Cash CapEx was $7 million for the quarter. We maintain our outlook for CapEx for fiscal year to be approximately $25 million.

With that, I'll turn the call back to David for his closing comments.

David Bradley

Thank you, Ross. In the last call, we mentioned that our first fiscal quarter is seasonally our weakest quarter and generally contribute at least towards the full year adjusted EBITDA. With that in mind, we saw the first quarter results coupled with the momentum we are seeing in the first half of the second quarter which is on track to meet the target of 10% growth for the full fiscal year adjusted EBITDA.

The early signs of optimism we mentioned in our last call are materializing in both stronger pricing trends and improve order pattern so far this quarter. The customer destocking trend we have seen over the last 12 months seems to be changing. If customers continue to replenish their inventories, it will benefit us through the rest of the quarter.

We are also seeing some benefit and momentum from recent supplier wins as our volume per day has been steadily increasing across many of our chemical end-markets. Energy is still down year-over-year in the first quarter, but demand is picking up with recent activity and energy services as rig counts continue to rise.

On the pricing front, chemical suppliers are continuing to push price increases, with several producers announcing price increase in January and more expected in February. In plastics, prices have gone up so far this quarter, but for how long remains to be seen as the market is still over supplied and domestic producers are expected the price aggressively to discourage imports in 2017.

With that said, we will continue to leverage our proprietary pricing tools to capture as much value as possible. Like many in the business community, we are encouraged by some of the positive sentiment developing in the economy. However, we need to see this euphoria materialized into real economic growth particularly in industrial manufacturing.

There are early signs of that happening, but the developing geopolitical landscape is still uncertain, so it's difficult to tell whether this demand increase will endure beyond a honeymoon period. If we see some lasting improvement in demand and a continued market results, towards holding or raising prices, we will see a sustained reversal of deflationary pricing environment we've been managing for the last several years, and we would be able to leverage the power of our centralized platform, our proprietary pricing tools and our go-to-market strategy into earnings growth.

Beyond the macro dynamics facing our business, our strategic focus remains the same. So, our commodity volume at 1.5 to 2 times GDP improved specialty mix continuing to expand our specialty line card through new supplier authorizations and growth these products at 2 to 3 times our commodities. Leverage our proprietary pricing tools to expand margins, expand EBITDA margins deleveraging our scale and driving productivity enhancements across the Company and supplement our growth through disciplined pursuit in execution of targeted bolt-on acquisitions.

I'll now turn the call back over to Michael to begin the Q&A session.

Michael Everett

Thank you. David. Operator, will you please take a minute to explain the Q&A process for our listeners.

Question-and-Answer Session

Operator

[Operator Instructions]. And our first question comes from James Sheehan with SunTrust Robinson Humphrey. Your line is open.

James Sheehan

Good morning. Could you tell us about the status of the supplier issue that you expect to still impact the fiscal second quarter, do you expect that to be resolved completely by the time the third quarter starts?

David Bradley

That's a good question. At this point, we're not in control. It's obviously an issue with that particular supplier. Have made progress steadily over the last couple of months, but just not at the rate we need them to substantially change the backlog or quite frankly even serve our current demand. So, we are hopeful that through the rest of this quarter, they will make progress and it will not be an issue in the last few quarters of the year. And we're working closely with them to manage both the supply constraints on their behalf as well as manage the issues with our particular customers.

James Sheehan

Great, and can you talk about what end markets you saw accelerate towards the end of the first quarter?

David Bradley

Sure I think, if you look at what's going on, I think we saw a broad industrial improvement across the board in many of our commodity products. And then we're seeing early season activity in the cake market as well our personal care market continues to be very strong. Overall, what I'd tell you is the general demand trend is positive, and it continues to move in the right direction.

Ross Crane

And James its Ross, as David mentioned, there is a lot of activity and energy, particularly out in the Permian basin. So the trend there is positive too.

James Sheehan

Great, and can you also discuss, what is your understanding of the WL Ross & Co. plans to sell their shares and the timing of that?

David Bradley

At this point, and so Wilbur has confirmed, there we are not commenting. I think Wilbur has a plan. He will work through that in a prudent fashion and in a responsible way and we'll wait to see what happens.

James Sheehan

Thank you.

Operator

Thank you. And our next question comes from Ian Bennett with Bank of America Merrill Lynch. Your line is open.

Ian Bennett

Thank you and good morning. Could you just talk through a little bit of doubt, guidance is well maintained. It sounds like there is some things that are getting better and worse calling out, cost savings look like they are better than expected, volumes are improving, and then on the negative side it seems like the supplier issue and a little bit on pricing pressure. Just kind of order of magnitude, how those variables have changed since your last outlook?

David Bradley

I think if you look at it, the first quarter as we've signaled came in right where we're expecting in line with our forecast. If I would tell you, I think the supplier issue plus a little bit softer pricing early in the quarter was offset by better cost performance. And I think if you look at the trend for the year, I think we're ahead of our expectations on productivity and cost. Our new supplier wins are pushing the top-end of the range that we had forecasted. Generally volumes are in line and you'll find just a slight bit of catch-up on price, but the trend is positive.

Ian Bennett

On the pricing side, what product are you seeing the most pricing pressure in across the portfolio right now?

David Bradley

It's not. I mean right now the underlying commodity trend is pushing price up across the board. Is it really recovering from what was an extended stagnant pricing period that pushed our margins down? It's – as you remember, our commentary over the last couple of calls, we talked about stagnant pricing being very difficult for us to manage and resulting in large compression and the fact that we experienced that for the most of last year, put us in a position that our margins were at historical or very close to historical lows.

Now that pricing volatility has returned to the industry, you know we're using proprietary pricing tools to capitalize on the sentiment and expand our margins. That's going on really across our portfolio with obviously the most volatility as it typically is seen in our plastics business, price move the fastest there.

Ian Bennett

Understood. And then one final one if I may, just on working capital, it seemed like it was a bigger use of cash in 1Q. Any comments around expectation moving forward on working capital for the year?

Ross Crane

Ian, it's Ross. We always have some interesting dynamics on working capital in the December quarter as producer shut down and customers decide whether they are going to pay bills at the end of the year or not. But essentially, if you look at the elements, the working capital usage which was probably a touch more than we expected was all on the accounts payable side. Inventory and AR actually came down. That will all normalize itself this quarter, so we're not alarmed by that at all and historically, I think except for last year, we've always used a little bit of cash in the December quarter, that was no change this year and it will all normalize. So, I don't expect any issues with that for the rest of the year. We'll still have pretty strong cash flow and working capital.

Ian Bennett

Thank you very much.

Ross Crane

You're welcome.

Operator

Thank you. And our next question comes from Andrew Buscaglia with Credit Suisse. Your line is open.

Andrew Buscaglia

Hey guys, thanks for taking my question. Can you talk about on that cost savings, can you just sort of quantify, is the bulk of that occurred in Q1, how much you expect going forward just as you know that sort of helped to offset some of the supplier issue, but if that supplier issue were to linger, do you still think you have enough savings in the back pocket?

David Bradley

I think we've talked about the range of 10 million to 12 million of productivity for the year. We're trending to the high side of that. Part of some of the change that we accelerated including restructuring of executive staff, the other moves that we've made on SG&A, a lot is to offset that supplier issue. And we expect to stay slightly ahead on cost and we expect the supplier issue to mitigate over time as we have – we see each month. So, we don't expect it to be a headline issue beyond this quarter and do think we have enough positive momentum to maintain our full year guidance for the year of 10% growth, that's what we did so.

Ross Crane

And to be clear, the supplier issue is not large enough to offset our cost savings not by any means.

Andrew Buscaglia

Okay and then, it's been a little bit quiet on the M&A front. Can you just give us an update there, if there is anything heating up or any change there in your priorities?

David Bradley

Yeah, I mean quite from what we've announced not quite from our effort and again just remember, we are very disciplined in our approach to M&A in this industry. We will continue to do so. We have active healthy pipeline. We're in discussions with various stages with several companies, but until we find the right deal at the right price the right time, we'll remain quiet publicly. Once we do, we'll make appropriate announcement.

Andrew Buscaglia

Okay. Alright, thanks guys.

David Bradley

Welcome.

Operator

Thank you. And our next question comes from Karen Lau with Deutsche Bank. You line is open.

Karen Lau

Thank you. Good morning everyone. So maybe going back to the supplier issue, is it more of a top-line impact, or is it more of a cost impact, you know because you may have to expedite some shipments and your cost associated with that, or is it a combination of both? Maybe you can quantify it a little bit for us and what type of drag would you be expecting in the second quarter?

David Bradley

Yeah, it's a top-line and margin issue. Our network is very efficient. So, we can move things when they are available around the country very effectively. So, it's a top-line and margin.

Karen Lau

And on the second quarter?

Ross Crane

Karen it's not. It's going to be similar in the second quarter as it was in the first quarter. It's not an issue that we have to excavate products, it's an issue they simply can't ship everything we need. So there's actually no way to expedite it. So, it's all margin. I would tell you that while we are a little bit concerned about it, it's certainly not going to derail us. It's not the kind of number that's alarming. It's the kind of number that is enough to make us pay attention.

David Bradley

It starts in the first quarter, seasonally our weakest quarter and this is one of our most ratable product families that we sell. So, as the rest of our business typically picks us seasonally, they will become less of an overall factor in our performance.

Ross Crane

The larger issue if it persists, customer starting to expect new product from different suppliers, that's the real issue.

Karen Lau

And that kind of leads me to my next question, because you mentioned that because of the issue, you have sales backlog kind of backorders from your customers. How – I guess how solid is that backlog would be at some point if this issue persists, some of these customers start to walk away or switch to other products and or even get resolved, should we expect you know to be a one-quarter you have a huge catch-up in volume, because all of a sudden all these product start to come in and you can start shipping it immediately. How should we think about that? And how big is that backlog?

David Bradley

I mean the backlog, it remains a pound. It's what I would tell you is mostly specialized products. It is in the short-term I'd say 80% stable meaning that the products that are in it are specified and likely to be sold once that they are available over the short-term. Over the long-term, obviously market animosity and customer frustration will dictate what they choose to do relative to their long-term supply needs. And so, it's really impossible for us to forecast all the customer's behavior relative to this particular issue that's going on for extended period of time.

We were fortunate that we had stocked inventory and were able to mitigate the issue for most of the first three to four months. It's really only been in the last kind of four months as it's gone on for an extended period of time, that start to affect our customers. And so we're working with them. I don't think you will see a big spike in any particular quarter, because many of these things are specialized and will move that backlog down over time.

Karen Lau

And then next question is on the other segment. So margins are weaker year-over-year and you talked about some mix issue, customers shifting to onsite services, somewhat of a temporary issue or is that going to be sustained throughout the year?

David Bradley

I think the margin compression year-over-year is really tied more so to the pricing cycle than anything else. As I mentioned earlier, we're coming off a period of stagnant pricing that you put a lot of pressure on our margins, and although we see a positive trend, we're starting from what is an historically pretty low point, we need to continue to expand our margins as pricing and volatility comes into an industry which it has. I mean I think you will see that trend overcome our year-over-year comp on a margin level. It's just really the starting point and how successful you are in this particular quarter.

Ross Crane

Karen, let me address your question, because I think you were talking mostly about the other segment. So, Yes, it's true that our mix in that business has shifted to onsite services which is slightly lower margin, still very healthy margins, but we have a number of initiatives in the other side of that business which is the waste business and carries higher margin, we expect to grow through the rest of this year, so we expect the margins overall in the other segment to stabilize and increase year-over-year in the last half of the year as the mix sort of balances itself back toward waste. And a little bit less to onsite services. I think that was your question.

Karen Lau

Yeah. That was very helpful. Thank you. Then also another question on mix, you mentioned oil and gas energy, there's been more activity obviously and I think one of your competitors has been sort of re-changing from that market because they couldn't get attractive pricing, so the volume that you're realizing or are going to realize in the energy volume. What kind of pricing are you able to get attractive pricing and is that going to be dilutive to your mix?

David Bradley

Yes. So we've had a very disciplined approach of our history with oil and gas and we continue to operates in line with our strategic objectives when it comes to that space. We have a limited number of partnerships for products that we feel meet our profitability threshold. We continue to pick up share very carefully based on the fact that we don't want to over expose our business to the cyclical nature of oil and gas and be subject to many of the commodity products which trade at little to no margin. And so, I think our discipline approach has allowed us to participate in that sector at a healthy level and we'll continue to manage that. Overall, I would tell you that our margins in that sector are on the lower side of our average, but I think they're still very good for the products that we choose to serve.

Ross Crane

And Karen, I would add, it's Ross. We're also not making big capital investments in that space that should the energy market stagnate again that we have a bunch of trapped capital. So, we are not playing in the business in that way.

Karen Lau

Got it. That's very helpful. And then last question for me. Could you remind us whether your business has much cross border activities? I realize you maybe sourcing from Europe for instance on some specialty products. If we do have more developments on the import and export taxes, how is it going to affect you? And also I guess on the other side, how much of the, I guess industry pricing pressure could be coming from the Chinese imports? And if we do have some development that could put a tariff on things, is that going to be a net benefit for you and for the industry pricing you think?

David Bradley

Yeah. So when you look at our exposure, obviously majority of our business sits in North America and the majority of that business sits in the continental United States. And our philosophy has always been we source locally and sell locally that is substantially true for most of our business. We do from occasionally when the products are specified and carry a high enough margin, ship and trade internationally on several ways, not only Europe to U.S. or Asia to U. S. or the U.S. to Asia. And it's really for those products that are specified, carry a higher value and use and have the margin structure to support that type of traded-flow activity with the distributor servicing it. That's a very small percentage of our overall business. So, generally speaking, we're in-country operator in most of our geographies.

Ross Crane

Karen, if you look at our exports versus imports, I'm while neither one is all that significant to our business. We export far more than we import.

Karen Lau

Okay. Got it. Thank you.

David Bradley

Welcome.

Operator

Thank you. [Operator Instruction] And our next question comes from Laurence Alexander with Jefferies. Your line is open.

Unidentified Analyst

Good morning. This is Ken on for Laurence. You mentioned [indiscernible] productivity gains returning for the high side. After you achieved that, is there another leg up you can take or is that probably kind of probably most you can get at this point?

David Bradley

No, I think, look, we have a very healthy culture of strong operating platform and every year we challenge ourselves to come up with productivity projects. I mean ways to improve the efficiency of our business. If you look at our track record over the last three to four years, you'll see a very healthy culture of optimizing our business, using our strategic platform and gaining more leverage in productivity. And obviously as time goes on, it becomes harder, but one of the biggest things we could do to improve overall productivity is grow volume and use that volume leverage on our very efficient platform to help our overall cost structure on a unit basis. I mean that's certainly part of our forward plan.

Unidentified Analyst

And then you mentioned you have a health M&A pipeline, but you know just no deals just yes, does that mean are people's expectations or in terms are expectations too high? Is that what you are finding or is there just something else?

David Bradley

Yeah. I think our view of the world and what we are willing to pay, I think we've publicly stated that generally speaking, we think deals are actionable at less than 8.5 times in this industry. Those are the type of deals that we are looking for and we prefer proprietary deals, because of disruption to the workforce at an auction process creates along with the potential disruption to the supply base. And so we are very disciplined in our approach and we'll remain so. And obviously, if you look at the deals that have happened in our space, they are north of that threshold and unless we had significant actionable synergies in the first 24 months, it will be hard for us to call an efficient use of capital to reach much above our 8.5% threshold.

Unidentified Analyst

Thank you very much.

Operator

I'm not showing any more questions. I'd like to turn the call back to Mr. Michael Everett for any closing remarks.

Michael Everett

Thank you, Operator. And as we conclude today's call, we will briefly scroll through the slides at the end of this presentation that contain the reconciliations of the non-GAAP financial measures discussed during our presentation today to the most comparable GAAP financial measures.

A copy of this presentation was included as an exhibit to our current report on Form 8-K we filed yesterday with the SEC yesterday afternoon. If you have any questions or feedback regarding this material presented, please contact Nexeo Investor Relations personnel by email at investor.relations@nexeosolutions.com.

We would, again, like to thank you for your participation in our quarterly update. We look forward to being with you again in May, when we report our second fiscal quarter 2017 results. Now, back to the operator.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may now disconnect. Everyone, have a great day.

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