GCP Applied Technologies' (GCP) CEO Gregory Poling on Q3 2017 Results - Earnings Call Transcript

GCP Applied Technologies, Inc. (NYSE:GCP) Q3 2017 Earnings Conference Call November 2, 2017 10:00 AM ET

Executives

Joe DeCristofaro - IR

Gregory Poling - President, CEO & Director

Dean Freeman - VP & CFO

Analysts

Jacob Schowalter - Seaport Global Securities

Nick Cecero - Jefferies

Christopher Shaw - Monness, Crespi, Hardt & Co.

Connor Cloetingh - KeyBanc Capital Markets

Operator

Good day and welcome to the GCP Applied Technologies Third Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Joe DeCristofaro. Please go ahead.

Joe DeCristofaro

Thank you, Stephen. Hello everyone, and thank you for joining us on today's call. With us on the call are Greg Poling, President and Chief Executive Officer and Dean Freeman, Vice President and Chief Financial Officer. Our earnings release and corresponding presentation slides for our third quarter results are available on our website. To download copies, please go to gcpat.com and click on the Investors tab. Some of our comments today will be forward-looking statements under U.S. federal securities laws. Actual results may differ materially from those projected or implied due to a variety of factors. We will discuss certain non-GAAP financial measures, which are described in more detail in this morning's earnings release and on our website. Our comments on forward-looking statements and non-GAAP financial measures apply both to the prepared remarks and to the Q&A. References to EBIT refer to adjusted EBIT and references to margin refer to adjusted gross margin or adjusted EBIT margin, as defined in our press release.

Greg will start us out today with a business update. Dean's commentary will include highlights of our third quarter financial results and outlook. We are discussing these results on a continuing operations basis to account for the sale of Darex Packaging Technologies and the deconsolidation of Venezuela as of July 3, 2017. All revenue and associated growth rates in this discussion are stated on a comparable constant currency basis, which adjusts for the impact of foreign currency.

With that I will turn the call over to Greg.

Gregory Poling

Thanks, Joe, and good morning everyone. I'd like to begin by saying that we are grateful all of our employees are safe following the recent hurricanes and earthquakes. One of our larger manufacturing facilities in Houston, we have plants and distribution centers in Florida, Puerto Rico as well as outside Mexico City. Many of our employees went through a difficult time with these events, and they made tremendous efforts to get our facilities back online and to service our customers who have also experienced disruptions. I want to thank our employees for their efforts.

I'm also pleased to report in the third quarter, we completed the sale of Darex and we expect to generate about $900 million in after-tax proceeds. We also announced the acquisition of Ductilcrete. Ductilcrete is a provider of concrete flooring systems. They have patented technologies that allow for replacement of virtually seamless floors in industrial and commercial buildings. Ductilcrete has lower placement cost and maintenance cost in traditional floor systems and the acquisition fits with our strategy of product line expansions and to bring a systems approach to construction applications.

As we pursue our bolt-on acquisition strategy, we are focused on high-margin, low capital intensity businesses. Those businesses should provide us with high performance product line expansions, the reduced construction cost, improve the quality and enhance lifecycle performance. We are also looking for technology sensors and data capabilities that deliver productivity, material savings and quality improvements, as well as bolt-on acquisitions that enable a systems approach to lower installed cost and deliver an integrated solution for construction applications.

Our financial performance in the third quarter did not meet our original expectations due to the weather in North America, increased inflation, the earthquake in Mexico and some lower volumes in Asia-Pacific. We did recently announce an across the board price increase to recover our cost and recapture our margins. A number of our businesses did perform well in the quarter. Cement additives grew in North America and Europe, and we are launching 2 new cement products this quarter, 1 for Vertical roller mills, which is a growing segment of the cement manufacturing business, and we're also launching a new quality improver for low alkali cements.

We did add new customers in Verifi and our install rate continues to grow at approximately 30%. Building Envelope within SBM had strong revenue performance led by North America in our Stirling Lloyd acquisition. We are executing on our realignment programs, we're making good progress on our plans to delayer and allocate resources closer to our customers. We have virtually completed the reorganization of our commercial and marketing teams, and we have eliminated much of the stranded cost associated with the Darex business.

Looking forward to 2018, we are currently developing our operating plan. We have a clear focus on the construction markets, growing our business and improving our margins. As usual, we'll provide full-year guidance in February on our fourth quarter earnings call after we've completed our operating plan. But our early indications are for sales growth of approximately 5% to 10% and earnings growth of approximately 10%.

I'd now like to turn the call over to Dean for more specifics on our quarter and our performance.

Dean Freeman

Thanks Greg, and good morning everyone. Just as a reminder, we are discussing results on a continuing operations basis to account for the sale of Darex, as well as the deconsolidation of Venezuela as of July 3, 2017. Also all revenue and associated growth rates in my comments are on a constant currency basis. GCP's consolidated revenues were up 7% to $282 million in the quarter. SCC sales were down 4%, as cement additives growth in North America and Europe was offset by a decline in our ready-mix business due to weather. Including the three hurricanes in North America, the earthquake in Mexico, SCC sales were also off due to lower volumes in Asia-Pacific. As Greg mentioned, Verifi installs grew over 30% year-over-year and revenue growth is now ramping up to catch up with the install rate. Going forward, Ductilcrete will be included in our SCC segment. The company's annualized revenue is about $10 million, margins are accretive to GCP as a whole and we paid less than 10x EBITDA for the acquisition.

SBM's revenue increased 25% year-over-year and it was up about 5% excluding acquisitions. Building Envelope sales increased 33% including Stirling Lloyd and 6% excluding the acquisition, with the liquid water proofing in particular performing well due to several large project wins. SBM specialty product sales, which includes our fire protection, injections and grouts business increased 42% including Halex and 14% excluding the acquisition. Residential sales declined due to reduction in inventories through our distribution channels. We expect our residential business to recover as storm-related rebuilding activity proceeds over the next few months.

On a regional basis, North America revenues were up 10%. Excluding the acquisitions, growth in the region was about 2%. SBM grew 20% including acquisitions and 3% excluding them. SCC was flat in North America as cement growth was offset by 1% decline in our ready-mix business. EMEA was up over 20% in the quarter, including Stirling Lloyd and 4% excluding Stirling Lloyd. SCC grew about 5% as cement and ready-mix admixtures business both increased. SBM grew about 3% excluding acquisitions. Latin America declined 19% in the quarter primarily due to deconsolidation of Venezuela and about 9% excluding Venezuela, including project delays in Mexico. In Asia-Pacific, revenues declined 5% in the quarter as 90% growth in SBM was offset by a decline in SCC due to our decision to maintain price discipline, which resulted in lost business. The increase in raw material prices we've recently seen in the region further strengthens our conviction in this decision. Conversion of new business to offset the Asia-Pacific volumes has begun and will contribute to our fourth quarter and 2018 revenues.

Moving to our earnings and margin performance, we experienced significant raw material inflation due to increased costs across the petrochemical chain. Raw material inflation was further impacted by environmental regulation in China and the hurricanes in North America which also caused logistical disruptions that increased operating costs. Adjusted gross margins declined 330 basis points to 38.1%, but the negative impact of raw material inflation accounted for about half of the decline and the balance split equally between higher logistics costs, and the combination of lower volumes and unfavorable mix.

Adjusted EBIT declined 5% in the quarter due to the lower adjusted gross profit. SCC's gross margins declined 400 basis points to 34% due to lower volumes and unfavorable mix. Again, the negative impact of raw material inflation and higher logistics costs. Segment operating income declined 32%. SBM's gross margins declined 360 basis points to 43% due to the lower residential volumes, which resulted in unfavorable product mix and the negative impact of raw material inflation and higher logistics cost. SBM segment operating income increased 18% in the quarter due to higher volumes and the impact of the acquisitions.

Rounding up the consolidated results for GCP in the quarter. Net interest expense totaled $14.5 million, adjusted EPS was $0.22 with diluted share count of 71.6 million. As we previously announced for 2017, we now expect revenue growth of 4% to 6% including acquisitions and adjusted EBIT in the range of $125 million to $135 million. We expect our adjusted effective tax rate for 2017 to be between 32% and 33% and our capital investments are expected to be less than 5% of sales. We're forecasting adjusted EPS range of $0.60 to $0.65 per share. And we are projecting $25 million to $35 million of adjusted free cash flow from continuing operations.

We're also on track to deliver our $5 million to $7 million of restructuring reposition savings in 2017 and we are increasing our expectation for annualized savings to $9 million to $13 million, $9 million to $13 million. Greg mentioned that we expect 2018 constant currency sales of 5% to 10% and approximately 10% growth in adjusted EBIT for 2018. In this preliminary outlook, we have built in moderate market growth as well as the annual impact of our acquisition and restructuring programs. Offsetting factors include salary and benefits, incentive compensation, investments in growth initiatives and other inflationary increases.

Our capital allocation framework remains consistent so far this year. We've acquired 2 companies, we've also retired our term loan and repaid the amounts outstanding on our revolving credit facility totaling about $400 million. We have ample liquidity and we'll continue our disciplined approach in allocating capital to support our growth strategies and lower our cost of debt.

With that, I'll turn it over to Greg for closing comments.

Gregory Poling

Thank you Dean, and just to wrap up, we did have a challenging third quarter but we are responding to those challenges and our business is well positioned for the future. We're fully focused on execution in 2018, including the implementation of our announced price increases to offset higher costs. We have a strong balance sheet, the healthy new product and bolt-on acquisition pipelines and we're optimistic about construction activity going forward.

I'd like to thank you again for joining our call. And now, Dean and I will be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions]. And our first question comes from Mike Harrison with Seaport Global Securities. Please go ahead.

Jacob Schowalter

Good morning. This is Jacob on for Mike.

Gregory Poling

Good morning, Jacob.

Jacob Schowalter

Could you guys give us some more color on the inventory reductions at the distributors? Has that run its course and returned to normal in Q4 or are you seeing a little bit additional effects in the quarter?

Gregory Poling

Yes I think it's a good question. What we did see was our distributors, primarily for our residential ICE & WATER SHIELD product take down their inventories. They actually had some pretty good sales, but decided I think going into the end of the year to bring inventories down from a cash basis. We also had some disruptions as you might imagine in some of those markets with the storms. So we expect that inventory to come back and get some build going into next year as it goes forward, but I think they made a decision given the economy take a little bit of cash management and that should bode well for us in the future.

Jacob Schowalter

Got it okay. And then one more looking at raw material inflation for 2018 versus the announced price increases, how much do you expect your raw material basket to be up and then what's the cadence for getting some pricing upside?

Gregory Poling

Let me just give you a big picture, then I'll have Dean just talk about the baskets for a second. We've said consistently, if we run into some big inflationary environment that it usually takes us a quarter or two to put that through. We are now out with pricing, we wanted to give our customers a heads up relative to their planning process, we're out talking to customers about those price increases. They're also seeing other inflationary pressures. So that starts to rollout, we'll start to see the impact of that. Some of the earlier ones that we put out in the quarter, we're seeing that we're getting the pricing. So we expect to get it. I would expect the margin to catch up into the second quarter next year, as the inflation runs its way through and our price increases pick up. But I think Dean can give you more specifics sort of on the supply chain issues that you asked about.

Dean Freeman

Yes, so it's a good question. As we think about our raw material purchases across the hydrocarbon chain, we're really looking at sort of a capacity constraint in the sort of in the month of September and looking out for the balance of the year. I think some of that moderates going out into 2018 but we've seen price increases year-over-year so far in ethylenes of over 10%, in propylenes of over 16%, butadienes I think we'll, as we saw capacity constraints at the early part of the years, has relieved somewhat, but again because of the overall disruption and capacity particularly in Asia, we've seen price increases there as well. Those affect our purchases in our latex, our rubbers, our amines, our glycols fibers and materials like that. But going into next year I think we're anticipating further -- some further inflation. And as Greg pointed out, our price actions are expected to offset some of that.

Gregory Poling

Yes, actually we'll recover on the margins going into a quarter or 2 here and we should then start to see some improvement.

Operator

Our next question comes from Laurence Alexander with Jefferies.

Nick Cecero

Hi, this is Nick Cecero on for Laurence. I guess if you could just provide some color on maybe order trends as we head into 2018 as we think about a cadence, are you seeing kind of steadier, your thoughts on that.

Gregory Poling

I'll let Dean give you more color, but as you -- we were optimistic on the second half of the year and seen a project activity come, especially in the SBM business. Despite some of these headwinds we had, the weather and the earthquake and all of that, you can see, we're starting to see some growth in the quarter, on the third quarter, that's continuing. And the project work, although it might have been delayed and some of it pushed in the next year, we like where the pipeline is that works out there and we're starting to see it. So from an order standpoint, this is a little later than we had anticipated going into the year for the reasons we talked about, but frankly, right now we're pleased with what we're seeing in the beginning part here in the fourth quarter.

Dean Freeman

Yes I'll just add that I think we can decide whether there is sort of order surge recovery or sort of the normal realization of the pipeline opportunities that we saw earlier in the year. As Greg pointed out, the pipeline is still up double digits going into 2018. We are seeing momentum going into, towards the beginning of the year. But I think as we get through the end of the year, we'll have more color and certainly provide more color as we get into our February earnings call.

Operator

And our next question comes from Chris Shaw from Monness Crespi.

Christopher Shaw

To start with the impacts on the quarter that we've called out, [indiscernible] bit more what the -- I guess the relative impact of sort of different buckets were. You have loss on some sales or orders on margins and how much of this is sort of the raw material spike from the hurricanes and how much is it just the increases, adjusted cost that the hurricanes also are sort of, I guess caused. I just trying to figure out what size or the relative size of those buckets maybe.

Gregory Poling

Yes, so I mean if you look across the business, we were down on a consolidated basis, gross margins were down around 330 basis points. I think as I mentioned in my comments, about half of that is related to inflation, about 170 basis points of that. The other half is split evenly between increases in logistics and about 80 basis points, another 80 basis points on volume and mix.

Gregory Poling

And just to add to that, we saw that inflation come through some of that was exacerbated as everybody knows with the storms. But the fact of the matter is, the pricing that we're out with is designed to bring those margins back and regain our momentum on the margin side given what's going on the hydrocarbon chain. And freight spin up, the hurricanes actually hurt that but anybody's been out trying to hire drivers or look at trucking readily, we think there's going to be some inflation there. So we're going to [indiscernible].

Christopher Shaw

And then now you have the proceeds from Darex, I know you are doing a lot of bolt-ons, you have a fairly decent cash balance now. I guess tapping out the other targets out there of the size of the sort of liquidity you have right now that you could possibly target or is there -- what sort of -- I guess how are you feeling now once -- now that you have it on the books ,the cash about buybacks, can you talk about your thoughts around that?

Gregory Poling

Yes sure. How we are feeling having it in the books, we're glad to have the cash. We're glad to have this process through. We've got a little bit more management to do as we run out of our transition services agreements over the next couple of quarters, but we're pleased and frankly, we're quite pleased with the work our team did on the tax planning and our ability to convert that purchase price into cash. So we feel good about that. Our strategy hasn't changed. We think there is a good opportunity for us to both invest in our organic business and to look for bolt-on acquisitions.

We're going to stay patient, we're going to have good discipline. We're looking for businesses that we said that we understand that fit into the markets that we know, but one of the reasons we talked about and have a slide in our deck, we think there is a product strategy, we think there is a data and sensor strategy that combines information management and productivity. And we also like the idea of Engineered Systems especially in segments where we have good product capability today that's what Ductilcrete's about. So we're planning to deploy that cash to grow our business, improve the business and if over the longer term it looks like we should return some of that cash to shareholders. We will look at that at the time, but right now, we think the best thing for us to do is reinvest in the business and grow on both inorganic and bolt-on.

Christopher Shaw

And I'm going to ask since you brought up Ductilcrete, what is the opportunity there, I mean how big enough this has become I don't fully understand or maybe exactly how -- I don't know what, what the opportunity is there?

Gregory Poling

Yes so, I mean this is a business in which they've taken flooring technology. We have some products that are in that business. We sell today fibers that end up in flooring systems. We saw shrinkage reducing admixtures. What Ductilcrete has done is taken concrete engineering to improve the performance of floors, taking out expansion joints, expanded those, make super flat floors, they've gone into a licensing program to place those floors in the marketplace and you essentially get a better performing floor with lower maintenance costs and lower installed cost.

We're going to add that system into our design assist engineering specification group to sell the developers, owners, [indiscernible] and general contractors on those types of buildings. We think the market is generally, if you just take the business that we bought, it's probably a $150 million market in North America. We think there are some opportunities to extend the technologies outside of North America. But the bigger idea for us is, this was a move into the systems side in which we're taking our product and design knowledge and adding that at a higher margin system. So we think this is a good start for us on what we think is a strategy to add value to the company.

Operator

[Operator Instructions]. And our next question comes from Connor Cloetingh with KeyBanc Capital Markets.

Connor Cloetingh

So I was just wondering with all the strong growth that you're seeing in Verifi, is some of that starting to translate incremental wins in your admixture business or how does the dynamic between those two businesses work?

Gregory Poling

I mean, we think Verifi has got a very unique position in the market, we think it provides us the opportunity to bring additional value to customers and as I said in the past about half of our customers traditionally are admixture accounts and some just buy Verifi with us. But today, we're also placing admixtures on the truck based on Verifi data. We're developing admixtures to be used with that system and as we go forward in developing the value proposition around Verifi, admixtures is a strong component there. So we think you'll see more combinations there and we'll be able to bring more value to the ready-mix producer by selling both admixtures and Verifi. You get value with Verifi independently, but we think going forward, the combination is going to be stronger and we're getting some good sort of runs on the places where we're putting admixtures on the truck.

Operator

This concludes our question and answer session for today. This also concludes our conference call for today. Ladies and gentlemen, thank you for attending today's presentation and you may now disconnect.