Forterra, Inc. (NASDAQ:FRTA) Q1 2018 Earnings Conference Call May 8, 2018 8:30 AM ET
Jeffrey Bradley - Chief Executive Officer
Charlie Brown - Executive Vice President and Chief Financial Officer
Mark Zhang - Oppenheimer & Co. Inc.,
Timothy Daley - Deutsche Bank
Jerry Revich - Goldman Sachs
Good morning and welcome to Forterra's First Quarter 2018 Earnings Conference Call. Today's call is hosted by Jeff Bradley, the Company's Chief Executive Officer, and Charlie Brown, the Company's Chief Financial Officer.
With that, I'll now turn the call over to Mr. Brown.
Thank you and good morning to everyone. Welcome to Forterra's first quarter 2018 earnings conference call. Before turning the call over to Jeff, I'll point out that Forterra intends to take advantage of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 as noted in the earnings release we filed this morning.
Please remember that our comments today may include forward-looking statements which are subject to risks and uncertainties and actual results may differ materially from those indicated or implied by such statements.
Some of these risks are described in details in the Company's SEC filings, including our Annual Report on Form 10-K. The Company does not undertake any duty to update such forward-looking statements.
Additionally, we will refer to certain non-GAAP financial measures during this call, including EBITDA, EBITDA margin, adjusted EBITDA and adjusted EBITDA margin. You can find the reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measures and other related information, including a discussion of why we consider these measures useful to investors in our earnings release.
We included all of the key performance metrics that we will be discussing today in our earnings release that is available on our website and, therefore, we’ll not prepare a separate presentation to accompany this call.
Now, Jeff Bradley, our Chief Executive Officer, will give an update on our business.
Good morning, everybody. And thank you for joining us on the call this morning. I am pleased to report that adjusted EBITDA for the quarter was above our guidance range on the strength of our Drainage business and lower costs in Corporate.
Starting with the Drainage business, we drove organic sales growth and strong performance in a number of our key regions as well as in our Bio Clean and Structural businesses that offset the impact of record rainfall in North Texas and snow and cold weather that continued through March in the Midwest, Mid-Atlantic and North. We were successful in securing higher selling prices and we are able to mitigate cost pressure on freight, labor, and raw materials, including steel, cement, and aggregates.
I am really pleased with the progress our team has made on the many procurement and operations initiatives that have been underway since last year, and we are seeing the benefit of the strategic transactions we executed in the second half of last year and earlier this year.
We ended the quarter with a strong backlog in Drainage, reflecting improving demand from our end markets and higher selling prices. I am really pleased with the good start to the second quarter we have seen in April and I am optimistic this strength will continue throughout the balance of the year. We have seen an improving pace of infrastructure work in many of the markets we serve. And the trends we are seeing in residential and commercial including our Central, West, Southeast, and North regions continues to be positive.
Turning next to the Water segment. As I discussed in the last earnings call, our results in Water were impacted by the significant upgrade project at our Bessemer, Alabama facility and by higher scrap costs. I am pleased to report that we are already experiencing cost savings in Bessemer and we are seeing improved plant efficiency as a result of the outage.
The benefit of our March price increase has started flowing into our backlog. However, we were not able to fully offset Q1 scrap cost increases. In the face of higher scrap costs, we are taking a more disciplined approach to pricing. We believe this approach is supported by healthy end markets and the inflationary cost environment that we are facing as an industry.
In Corporate, we are incurring lower professional fees and we are continuing to uncover opportunities for additional improvement. In summary, I am pleased with the progress we made in Drainage and Corporate and I am optimistic about our ability to drive improved results in Water and I am encouraged by healthy end market demand.
With that, I’ll turn the call over to Charlie.
Thanks, Jeff. In the first quarter we recorded a net loss of $20 million, but delivered adjusted EBITDA of $15 million above our guidance range. Organic sales declined 3% for the quarter as compared to the first quarter of 2017, including 4% growth in Drainage segment offset by 11% decline in the Water segment.
In Drainage, we were pleased to deliver higher organic shipments in spite of the challenging weather Jeff mentioned and higher selling prices on both a year-over-year and sequential quarter basis. We generated higher gross profit and our adjusted EBITDA margin increased to 14% on the benefit of higher selling prices and our procurement initiative focused on mitigating inflationary cost pressures. While we are pleased to see progress in our performance, our Q1 2018 margin in Drainage remains well below the level we achieved in Q1 2016.
We are focused on driving pricing actions and cost reduction initiatives to restore and eventually surpass historic margins. In Water the organic sales decline of 11% was driven by the downtime at Bessemer associated with the upgrade project, as well as by unusually frequent and late season cold and snowy weather in the North, Mid-Atlantic and Midwest regions.
Consistent with our comments in the Q4 earnings call, the Bessemer project produced Water earnings in the quarter by approximately $10 million due to unabsorbed costs as well as lost and deferred sales. Our results in Water were also impacted by a significant rise in scrap costs that have not yet been offset by higher selling prices. Our experience in this industry indicates that higher margins are achievable and we are keenly focused on offsetting higher input costs through price.
In Corporate, we reported an adjusted EBITDA loss of $15 million below the same period last year of $19 million and below the level we communicated in our Q4 earnings call. The improved year-over-year results reflect the benefit of lower professional fees and continued cost saving initiatives.
In regards to the balance sheet, we ended the quarter with $53 million in cash and no outstanding balance on a $300 million revolving credit facility. Our change in working capital and capital expenditures for the quarter were consistent with our expectation relative to the communicated key cash outflow components for 2018 from our Q4 call and well below the prior year levels.
Turning next to our forecast for Q2 2018, we expect adjusted EBITDA to be in the range of $50 million to $58 million. In Drainage, we expect to deliver continued gradual year-over-year improvement including sales growth on the benefit of higher shipments and higher selling prices mitigating the impact of continued input cost inflation.
In Water, we expect to see a decline in adjusted EBITDA and adjusted EBITDA margin as compared to the same quarter last year as a result of significantly higher scrap costs. We are not perfectly correlated with our cost. The American Metal Market U.S. composite shredded auto scrap average price rose about 20% in Q1 of 2018 as compared to Q4 of 2017.
While we are seeing success from the price increase that we announced in early March and our selling prices in backlog are moving higher. Second quarter margins in Water will continue to be negatively impacted as our product pricing continues to catch up to the higher input costs.
As Jeff mentioned, we are responding to higher scrap costs with an increasingly disciplined approach to our pricing and we expect to drive higher selling prices to mitigate the inflationary pressure from the scrap in the second half of 2018.
Given the potential for this pricing strategy to impact our shipments, we anticipate recovering somewhat less of the first quarter lost and deferred sales associated with the Bessemer project over the balance of 2018. Our expectations with regard to the Bessemer cost savings, however, remain unchanged. We believe that this more disciplined pricing approach will better enable us to improve our profit and returns in Water over the longer-term.
In summary, we remain focused on growing high margin business, driving increased operational efficiency and lowering our cost structure. We continue to expect full-year 2018 adjusted EBITDA and margin to improve as compared to 2017, in spite of the near-term challenges in Water and we remain optimistic about our ability to continue to drive additional earnings improvement in 2019 and beyond.
We see significant growth in earnings potential from Bio Clean and are more innovative precast products and we continue to evaluate strategic bolt-on acquisitions to enhance our capabilities and presence in key regions.
That concludes our prepared remarks. Operator, will you please open the line for questions.
Thank you. [Operator Instructions] And our first question comes from Ian Zaffino from Oppenheimer. Your line is open.
Hi, guys. Good morning. This is Mark on for Ian. Thanks for taking my questions. So good quarter, in regards to the – digging into a higher raw materials and scrap cost in Water, certainly want to see timing or lag impact of typically passing through the higher prices compared to what you're seeing on the increases in scrap? And how confident actually are you guys in passing through as scrap continues to grow going through maybe the balance of the year? Any color in – additional color would be much appreciated. Thank you.
Hey, Mark. Good morning. This is Jeff. Thanks for the question. As I stated in the remarks, the March price increase in Water has started flowing into the backlog. We've taken a more disciplined approach to pricing. It's working. In scrap cost, we did see a pretty significant increase in the first quarter. I think as we look at the rest of the year, we could see a leveling off this summer, but we would expect prices potentially increase again as we get into the second half of the year.
Okay, gotcha. That's helpful. And then in regards to Bessemer, now that the project completed, is there anything that you guys can provide in terms of quantifying the impact to Water segment margins or any additional details surrounding that would be helpful as well? Thank you.
Sure. Let me give everybody an update on the Bessemer plant. First, the plant is fully functioning. We already seen a raw material savings that we had talked about when we put the outage in place. Our productivity continues to improve in Bessemer. May is starting out strong and we will continue to work to make the lost production we had in Q1.
Okay. Terrific. Thank you very much.
Thank you. And our next question comes from Nishu Sood from Deutsche Bank. Your line is open.
Hey. This is actually Tim Daley on for Nishu. Thanks for the time. So I guess the first question just digging a bit into the Drainage side of things. So you mentioned that you were able to kind of mitigate the cost inflation on several of the components feeding in there freight, aggregate, cement, and just curious could you walk us through each of the – kind of those input costs and how you are able to kind of offset those what cost savings are getting?
And on the past, you’ve mentioned on – some procurement advantages that are buying, I just seems having a lot of strong pricing of the manufactures of those raw materials. So just curious if you could help provide us bit of some anecdotes or color around how you guys are successfully, I guess offsetting those costs? Thank you.
Sure, Tim. This is Charlie. May I think we don't want to go into a lot of details on the various components, but obviously we did invest a quite of bit of money last year in our procurement initiative? Jeff and I have both talked historically about just the ability to utilize Forterra’s strength across the different markets. Historically, we've been much more of an independent operating buying and local markets, now we are able to leverage that.
I think we are demonstrating in the first quarter that we did get a benefit from that and we would continue to push on those levers. I’d say each component has very unique characteristics. And how we exercise that I think is there find a magic here, but it's also there is sensitivity.
So we recognize that raw material costs are going up we certainly are working very hard on the freight angle I think that's a really good challenge across the country and we continue to work in that. Steel is certainly an area where everyone has seen. We've taken I think some pretty good movements in cost, but where we haven't been able to get the mitigating through procurement we are getting price and we'll continue to push on both of those levers going forward.
Just adding to that, one of the actions I took last year is we went outside and we really brought in some more – some higher powered procurement people. We have a great team now. On the freight side, really where we've done a better job is making our Company, a company that people want to awful.
We've done a better job of staging trailers, getting trucks in and getting trucks out quickly that's really the key today for trucks to be able to get in and get out fast and we've really worked hard on that across the business, not only in the Drainage business, but also in the Water business.
And I would just add we had great people in procurement before, but they were very focused on individual markets. They didn't have the power to work together as a team. So what we did last year with Jeff’s comments and bringing some real talent you had done things across the nation and really pulled that team together and I think given them the power to be successful.
It’s very helpful. And then I guess moving on to the comments that April. I just curious was that particularly pointed towards the Drainage segment or just overall you're seeing kind of improved based infrastructure work? I know you mentioned some of the regional areas where it was strong particularly calling out residential and commercial.
Just curious, are there any markets in particular where you're seeing I guess the infrastructure pace improved particularly in your segment. And I guess where on the Drainage or Water side, are there some regions that are standing out in particular or I guess lagging behind what you may as expected...?
Looking to key to that question is the strongest markets in infrastructure are the markets that have healthy state funding. You asked for a couple of examples – two examples that would be Texas and Florida. We expect the funding to continue to improve probably not the pace we'd like to see it. We've talked a lot in the past about FESTAC, which is a tied to infrastructure that continues to ramp again the impact. The ramp is not as big as we'd like, but it does continue to ramp up.
I mean I think there's been a good demonstration across the country, even earlier in the year, things like we look at Colorado. We look at Minnesota, even California. We're looking at some positive demand and I think that's important for us to – it's early seasons. This is a business, which is very seasonal. So it's still – we've got a lot to prove and our job here is to deliver on value and I think demonstrated that we do not like to talk about things and so we’ve actually proven that we can deliver it. So hopeful that makes sense to you. Thanks Tim.
Now it makes full sense. Thanks for the time.
Thank you. And our next question comes from Jerry Revich from Goldman Sachs. Your line is open.
Yes. Hi, good morning, everyone.
Really strong performance within Drainage in the quarter, I'm wondering if you can just help us with a little bit more granularity of the gross margin improvement year-over-year. Can you just help us with the sizes of the buckets, how much is pricing, how much is improved logistics, lower supply chain costs, so just flesh that out for us if you don't mind?
Jerry we're not going to really give specifics on each of the buckets, but let me talk just in general. We've done a good job on price increases across the country. We put through multiple increases in many of the regions. On the operational side, we have a lot of great initiatives going on. Brought in a couple new people on the ops front. You got a lot of lean work going on. We've attacked our largest plants first where we're going to see the biggest impact at Texas.
We now have a lean team that we're spreading across the balance of the plants, so that's working out very, very well. I’ve talked about the procurement side, cost saving side. We've got a really good team there. At the end of the day everything gets down to leadership and we're really feeling good about the leadership we have in place on the procurement front, on the operational front, and on the sales front.
And I’m wondering if you'd be willing to expand more on the procurement side, so a lot of the inputs are up significantly, transportation costs are up significantly, so it's really interesting to see your supply chain, cost savings, year-over-year in the quarter. Can you just say more about what's driving that? How much of that is supply or consolidation? Any detail you can share to help us understand it better because the freight costs for the industry are up significantly, input costs for the industry are up significantly, and so it's really nice to see your performance if you just help us understand a little bit better why you folks are able to zag well, others are zagging, that would be helpful?
Well I think we're all zigging. And I think we're all doing what we can in this area, Jerry, but it is coming from perhaps a low base to start with. We are certainly demonstrating a very focused leadership team, which is trying to prove what we can do, and again this is Q1.
So volumes are very light. This would be our weakest quarter going forward, and we will see additional costs coming through in Q2 and Q3. And that's what the pricing initiatives have been designed to offset. Obviously, we have backlog, Jerry, which takes time to work through. So whatever we had, we carried in. We are stuck with for Q1. We will see improvements in our pricing in Q2 as well as our cost in Q2.
So again watch for us to continue to deliver or attempt to deliver on these sites zigging as you said. And hopefully be able to demonstrate margin improvement, which is really then the underlying goal for our business. We've got a lot to recover, and 2017 was a tough year for us. 2018 we’re starting off. We have lots to prove. We look forward to delivering on that.
Okay. And then can you comment within Drainage? How does the cadence and magnitude of pricing actions you’ve announced so far for 2018? How does that compared to the cadence and magnitude of pricing actions in 2017?
Again as I said, I'm not going to really get into the specifics. But I think the market understands, our customers understand, there's been a significant amount of cost inflation that we've got to cover as a Company and steel is a big component of COGS. So that's a big component aggregates. So we've talked a lot about that to customers. It's in the news. They understand it and our guys have done a really nice job of being able to cover all those additional costs.
I think the fact that it is much more prevalent across the group, you certainly highlighted yourself, Jerry, everyone is expecting this, and so we're not alone in our quest, and I think that gives us the importance in – both on the Drainage side and on the Water side where we feel that we will be able to offset good portion of our cost because the demand is out there, it’s great fundamentals that we continue to – will continue to build on.
Okay, thank you. Nice quarter.
Thank you very much.
End of Q&A
Thank you. And that does conclude our question-and-answer session for today’s conference. I would now like to turn the call back over to Jeff Bradley for any closing remarks.
Okay, thank you everybody. We really appreciate your interest and we look forward to seeing you on the next call. Thank you.
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may all disconnect. Everyone have a wonderful day.