ZCL Composites, Inc. (OTCPK:ZCLCF) Q2 2018 Earnings Conference Call August 10, 2018 11:00 AM ET
Ronald Bachmeier - President and Chief Executive Officer
Kathy Demuth - Chief Financial Officer and Corporate Secretary
Good morning, ladies and gentlemen. My name is Joanna and I will be your conference operator today. Welcome to the ZCL Composites, Inc. Second Quarter 2018 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] I would like to remind everyone that this conference call is being recorded today, August 10, 2018.
Before the conference call begins, I would like to caution you that ZCL's statements today contain forward-looking information concerning events or ZCL's future performance. Actual events or results could differ materially from a conclusion, forecast or projection in such forward-looking statements due to a number of known and unknown risks, uncertainties and other factors affecting ZCL's business, industries ZCL serves, and the economy generally. I refer you to ZCL's second quarter 2018 financial results news release and other written disclosure documents.
I will now turn the call over to Ron Bachmeier, President and CEO. Please go ahead.
Thank you, operator. Good morning, ladies and gentlemen. With me today is Kathy Demuth, our Chief Financial Officer. And thank you for joining us on this call.
As you have seen from our news release yesterday, ZCL's Board of Directors has appointed Mr. Ted Redmond as the company's new President and CEO. Mr. Redmond will start at ZCL on September 10, 2018. His appointment follows a comprehensive and successful recruiting search that the Board started in early November 2017. Mr. Redmond is a very successful leader, with a wealth of experience and expertise of high value to the company. I'm confident that ZCL will continue to grow and prosper under Ted's leadership.
As previously announced, effective September 9, I'm retiring as ZCL's President and CEO. However, I'm eager to continue to participate as the ZCL Board Member in an advisory capacity to help ensure a smooth onboarding and transition to Mr. Redmond's leadership, a process which has already started. I know the entire management team and our organization at large is very excited to welcome Mr. Redmond.
Before I turn to the quarterly results, as you've seen our disclosure yesterday, the Board has declared a quarterly dividend of $0.135 per share. This is the same rate as the prior quarter and a 13% increase over $0.12 per share declared at the same time last year. The dividend will be paid on October 15, 2018, to the shareholders of record as of September 30, 2018.
Moving on to our quarterly performance, you can review the full quarterly and first half of the year information in the statements in MD&A we have filed with SEDAR or on ZCL's website. We will focus primarily today on the quarterly figures. In the second quarter of 2018, revenue increased compared with the first quarter of 2018. However, as we expected it did not match the exceptionally strong results the company achieved in the same quarter of last year.
Total revenue in the second quarter of 2018 was $46.8 million, down 12% from $53.3 million in the second quarter of 2017. Fuel revenue of $40.7 million was 5% from $42.9 million in the same quarter last year. North American fuel revenue was comparable with the same quarter a year earlier on a source currency basis. The decrease compared with 2017 was due to a negative impact from the translation of U.S. dollar denominated revenue to Canadian dollars for reporting purposes and a decrease in international fuel revenue.
Canadian fuel revenue in the second quarter of 2018 was up $0.3 million or 5% compared with the same quarter of 2017. Distributor and contractor sales increased compared with the year earlier. In the U.S., fuel revenue was comparable with the second quarter of 2017, prior to a $1.4 million negative impact on the translation of U.S. dollar sales to Canadian dollars for reporting purposes. Sales to U.S. distributors were up by 9%, while sales to retail petroleum marketers were down 5% with the same quarter a year earlier.
Revenue from international operations was down $1 million with the decrease related to lower Parabeam 3D fabric sales to our international licensees.
In the Water & Wastewater segment, our revenue in the second quarter of 2018 was $5.1 million, down 24% compared to $6.7 million in the second quarter of 2017. The decrease in revenue came from the U.S. markets, which were down $1 million or 24% over the second quarter of 2017 prior to a $0.5 million negative impact on the translation of U.S. dollar sales to Canadian dollars for reporting purposes. In Canada, Water revenue was down $0.1 million compared with a year earlier.
In submarkets of the Water & Wastewater segment, increases in water collection and conservation in industrial wastewater applications were more than offset by decreases in wastewater fire protection in plumbing engineered solutions compared with the second quarter of 2017.
In the Oil & Gas and Industrial segment, second quarter revenue was $1 million, down 72% from $3.6 million a year earlier. Oil & Gas revenue was down $1.2 million and Industrial Markets revenue was down $1.4 million.
As a reminder, during the third quarter of 2017, the company decided to cease offering products to industrial markets, including aboveground chemical storage tanks used in oil sands applications, so that should be taken into account in the comparison analysis. In terms of profitability in the second quarter of 2018, the combination of decreased revenues, increased resin input costs, competitive pricing pressures in certain markets, plus expenditures on the workforce expansion and employee training, product and process standardization and manufacturing and plant safety improvements that we have discussed on prior calls have all contributed to our reduced level of profitability, when compared to the same time last year.
Due in part to a tightening labor market with some areas of North America experiencing the lowest levels of unemployment we have seen in many years, we've encountered challenges in implementing certain of the initiatives related to manufacturing. This has led to inefficiencies and reduced throughput when compared with a year earlier.
Net income for the second quarter of 2018 was $3.9 million, down 31% from $5.7 million a year earlier and earnings per share for the second quarter of 2018 was $0.13 compared with $0.18 per share a year earlier.
I will now turn the call over to our Chief Financial Officer, Kathy Demuth. Kathy?
Thank you, Ron. Good morning, everyone. In the second quarter of 2018, gross profit was $8.4 million, down 29% compared with the same quarter in 2017. Gross margin also decreased from 22% to 18%. The gross profit and gross margin year-over-year decrease was attributable to a relative decline in revenues, resin price increases, customer sales mix and increased costs - fixed costs relating to manufacturing expenditures in combination with a tightening labor market.
As Ron has shared with you, we have been making investments in manufacturing, sales and marketing and employee safety to better support both our short- and long- term targets. In implementing some of these initiatives relating to manufacturing, particularly from the manpower staffing and training perspective, we've been encountering challenges. This has led to manufacturing inefficiencies and reduced throughput through the second quarter of 2018, when compared with a year earlier.
The products and process standardization and productivity initiatives are taking longer to implement than initially anticipated, however, we remain confident that they will yield benefits over the longer term.
General and administration expense for the quarter ended June 30, 2018 was $2.8 million, up 10% from $2.5 million in the same quarter of 2017. This resulted from an increase in professional fees that was partially offset by reductions in incentive compensation.
Foreign exchange gain of $0.5 million in the quarter was the result of fluctuations in the U.S. dollar conversion rates and the U.S. dollar denominated monetary assets and liabilities held by the company's Canadian operations.
Depreciation and amortization expense for the quarter was $0.7 million, down 10% compared with a year earlier. And income tax expense in the quarter represents 27% of pretax income compared with 29% of pretax income in 2017. The decrease in the effective tax rate is primarily due to the impact of U.S. tax reform.
As at June 30, 2018, the company decreased working capital to $37 million from $52.9 million as at December 31, 2017. The $15.9 million decrease was primarily the result of the payment of $12.3 million in special dividends on June 15. As at June 30, 2018, the company had bank indebtedness of $1.1 million compared with $25.6 million in cash and cash equivalents as at December 31, 2017.
We continue to believe that internally generated cash flows, along with the available revolving credit facility will be sufficient to cover the company's anticipated operating and capital expenditures for the foreseeable future.
On a more personal note, I would like to thank you, Ron, for the pleasure of working with you for almost 10 years. I wish you well in your retirement and look forward to tapping into your expertise in your advisory role moving forward. I would also like to say that I'm greatly looking forward to working with our new CEO, Ted Redmond, who is starting in September. I will now turn the call back to Ron for a discussion on backlog and outlook.
Thank you, Kathy. At the end of the quarter, our backlog was $52.3 million, up 2% from $51.5 million a year earlier. In the Fuel Markets, backlog of $45.9 million was 1% higher year-over-year. This modest increase came from our Canadian fuel markets, which were up $0.5 million and from our international markets where backlog increased by $0.4 million compared with the same time last year.
On a source currency basis, the U.S. fuel backlog was down $0.8 million or 2% compared with the same quarter a year earlier. This decrease was partially offset by a $0.3 million increase due to foreign exchange translation of U.S. dollar denominated backlog. Water & Wastewater Markets backlog of $5.8 million, was up 21% from $4.8 million in the same quarter of 2017.
U.S. Water & Wastewater Markets were up $0.7 million compared with a year earlier. This was prior to a $0.3 million positive impact on the conversion of U.S. dollar denominated backlog to Canadian dollars for reporting purposes. Canadian Water & Wastewater Markets were comparable with what we saw in the second quarter of 2017.
In the second quarter, our Oil & Gas Market backlog was $0.5 million, down 54% from $1.1 million a year earlier. This was largely due to ZCL's decision in 2017 to cease offering products to Industrial & Oil Sands Markets.
On a sequential quarter basis, the total backlog increased by 16% from $44.9 million at March 31, driven by both the Fuel Markets and Water & Wastewater Markets, which were up $5.4 million and $2.1 million, respectively. At the same time, Oil & Gas Market backlog were down $0.2 million compared with March 31 due to the normal seasonal nature of that business.
In terms of our outlook, for the full year 2018, we expect revenue to be comparable with 2017. Revenue growth in our core Fuel Markets is expected to come from the continued replacement of the aged infrastructure and new to industry construction and continued market share gains against steel. The increased order entry in Fuel Markets we are seeing supports our expectation for the remainder of the year. At this point in the year, we believe our emerging Water & Wastewater Markets revenue will be comparable with the year earlier.
We continue to work on improving profitability. However, for the full year 2018, we expect lower profitability relative to the prior year due to a combination of factors I have referenced at the start of this call. We expect that the rising resin input costs, competitive pricing pressures and a temporary reduction in production efficiencies that we have experienced in the second quarter of 2018 will persist through the rest of the year.
At the same time, over the longer term, we remain confident in meeting our 10/10/10 objectives of revenue, profit and dividend growth. But as we have said before, the achievement of these goals is not guaranteed in each individual year, and 2018 is a case in point. In terms of specific segment outlook, in the Fuel Markets, we're seeing growth in sales to smaller independent retail petroleum marketers through our North American leading distributor network and increased orders from certain larger retail fuel marketers who deferred spending in 2017.
As I have shared with you on prior calls, we think that as the industry continues to consolidate, we expect larger customers to integrate newly acquired stores and eventually return to upgrading and replacing their aged infrastructure of underground storage tanks. This will be a company by the construction of new to industry sites as they seek to gain market share.
Industry consolidation over a longer term, along with the trend of increased sales to smaller independent retailers will be of benefit to ZCL. The fuel industry is looking for solution providers they can trust to serve them throughout the entire North American geography, and ZCL is well positioned to be a preferred supplier.
We continue to consider the Water & Wastewater Markets as part of our emerging business with the most potential for significant relative growth in the future, even though we have participated in these markets for several years now. These markets remain a fundamental part of ZCL's long-term growth strategy.
As I've shared with you on past calls, we have completed extensive independent market research that supports our optimism about longer-term growth opportunities in the Water & Wastewater Markets. We think the addressable market for the tanks that ZCL currently supplies is in the range of $400 million to $600 million annually. We continue to believe that we can take market share away from concrete, which currently dominates the space with north of 70% market share, compared with less than 10% for FRP solutions.
In order to accelerate growth, we have made many changes to our Water & Wastewater sales and marketing strategies, and tactics, over the past 12 to 15 months, with the intent of promoting our FRP solutions as a superior alternative to the incumbent concrete solution. These changes, among other things, have included hiring a new Vice President of Sales for the Water & Wastewater group, expanding our marketing team with an increasing focus on digital and e-marketing initiatives, expanding our product offerings into new market segments, expanding our field sales organization to make more customer and influence our context earlier in the sales cycle, with a special emphasis on specification writing, and investing in the implementation of a customer relationship management system using Salesforce.
Results of these efforts are not immediately visible, because the sales cycle in these markets is much longer than that of our core fuel markets. Although order intake in the first half of 2018 has been lower than anticipated, it has accelerated in recent months. And our agent and distribution networks have started to see robust quoting activity. Much of this increased activity is due to our deliberate efforts to educate specifiers and the expansion of our distributor and representative networks.
Finally, for our Oil & Gas Markets, the near-term outlook remains limited by midstream pipeline regulatory approval and other macroeconomic challenges. But there are areas of opportunity for our product portfolio, including the potential to displace incumbent steel tank providers, both at the wellhead and in pipeline infrastructure.
Specific ongoing initiatives for our Oil & Gas Markets include our sales and product innovation teams collaborating to create new product designs that better address customer needs, creating an established agent and distributor network throughout North America and refocusing sales efforts to grow the share of business from the existing customers.
This concludes my remarks. But before we open the line to questions, I want to thank you for your interest in ZCL and our many conversations during my tenure as CEO. It's been a pleasure to work with you. I have a great sense of pride in what ZCL has accomplished. I would like to say that I have been uniquely blessed to have had the pleasure of working alongside many talented and dedicated people, both inside and outside the company during my tenure with ZCL.
I'm very confident in the future of this company and its people, particularly under the new leadership of Ted Redmond, as he and the ZCL management team put in motion ZCL's next chapter of profitable growth.
That completes our remarks today. Operator, please open the line for questions.
Thank you. [Operator Instructions] One moment please, for your first question. At this time, we have no questions. I will now turn it back over for closing remarks.
Thank you for attending our second quarter 2018 investor conference call. Our new CEO Ted Redmond and Kathy will be hosting the company's next quarterly call in November. Thank you very much and goodbye.
Ladies and gentlemen, this concludes today's conference call. We thank you for participating. And we ask that you please disconnect your lines.