Forterra's (FRTA) CEO Jeff Bradley on Q1 2019 Results - Earnings Call Transcript

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About: Forterra, Inc. (FRTA)
by: SA Transcripts
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Earning Call Audio

Forterra, Inc. (NASDAQ:FRTA) Q1 2019 Earnings Conference Call May 7, 2019 10:00 AM ET

Company Participants

Charlie Brown – Chief Financial Officer

Jeff Bradley – Chief Executive Officer

Conference Call Participants

Timothy Mazurczak – Citi

Rohit Seth – SunTrust

Matthew Bouley – Barclays

Tim Daley – Deutsche Bank

Ben Burud – Goldman Sachs

Operator

Good morning, and welcome to Forterra’s First Quarter 2019 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 would now turn the call over to Mr. Brown.

Charlie Brown

Thank you, and good morning to everyone. Welcome to Forterra’s First Quarter 2019 Earnings Conference Call. Before turning the call over to Jeff, I will point out that Forterra intends to take advantage of the safe harbor provision of the Private Securities Litigation Reform Act of 1995 as noted in our earnings release we filed last night.

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 detail 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 the call, including EBITDA, EBITDA margin, adjusted EBITDA and adjusted EBITDA margin. You can find a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measure and other related information, including a discussion of why we consider these measures useful to investors in our earnings release.

Now Jeff Bradley, our Chief Executive Officer, will give an update on our business.

Jeff Bradley

Good morning, everyone. We appreciate you joining us on the call this morning. I’m pleased to announce that we’ve gotten off to a good start this year. Despite record rainfall on the West Coast and excessive rain in the Southeast, our adjusted EBITDA came in slightly higher than we expected mainly driven off the continuing strength in our Drainage business and the ongoing efforts around proving our operating performance in both the businesses.

Backlogs in drainage and water are strong, each with higher pricing and volume in the first quarter of last year. And as I said on our last call, we expect further margin improvement this year over last year.

I also want to highlight that we made changes to the top leadership in both businesses in the quarter. Rich Hunter was our Chief Operating Officer, and he’s now the President of the Drainage business. He has 30-plus years of operational experience, and he’s already launched a number of initiatives to improve our operating performance and drive our production cost down. Vik Bhatia is our new President of the Water business. Vik has been leading our commercial efforts at U.S. Pipe since the middle of last year, and he’s made improvements that will positively impact our margins this year.

While the housing starts have been somewhat mixed since the start of the year, the infrastructure market continues to be strong, and we remain optimistic about the demand outlook for the balance of this year.

Finally, we are also continuing to execute on our planned operational improvements in both the businesses, and we expect that margins will be higher than last year.

With that being said, I want to reaffirm our guidance for adjusted EBITDA to be in the range of $170 million to $200 million.

With that, I’ll hand the call over to Charlie.

Charlie Brown

Thanks, Jeff. In the first quarter, we reported sales of $292 million, gross profit of $42 million and adjusted EBITDA of $20 million, all above prior year performance. In Drainage, we delivered a higher sales, gross profit, adjusted EBITDA and adjusted EBITDA margin than first quarter of last year on lower volume.

Higher selling prices, lower rent expense and the benefit of our cost in operational initiatives more than offset the impact of lower volume and cost inflation.

In Water, our volume and sales were lower than prior year, but gross profit, adjusted EBITDA and adjusted EBITDA margin were all better than first quarter 2018.

Higher selling prices and increased manufacturing efficiency as well as the prior year operational challenges at our Bessemer plant offset the impact of lower volume and higher raw material costs.

In Corporate, adjusted EBITDA losses of $15 million were in line with prior year performance.

Regarding the balance sheet, we ended the quarter with $8 million in cash and $42 million outstanding on our $300 million revolving credit facility. We expect to use this facility to fund working capital needs through the second quarter as we take a closer look at opportunities to enhance our inventory management. Serving our customers’ needs remains paramount, but we plan to match that with prudent production planning and flexibility.

We anticipate further strengthening and public infrastructure spending, continued positive pricing trends and stabilizing input costs. In addition, we are focused on executing commercial and operational initiatives geared toward improving operating margins and cash flow.

We believe, we are well positioned to deliver progress this year at both our business segments. Thus, we are reaffirming our 2019 outlook forecasting adjusted EBITDA of $170 million to $200 million, and voluntary repayment of our term loan in the range of $30 million to $85 million. That concludes our prepared remarks.

Operator, will you please open the line for questions?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question or comment comes from the line of Scott Schrier from Citi. Your line is open.

Timothy Mazurczak

Hey, it’s actually Tim on for Scott. I just wanted to ask about the impact of the rising market and all the businesses, and particularly the Water business and the demand expectations going forward?

Jeff Bradley

This is Jeff. As I said in the comments, demand is good in both the businesses. We were impacted more than anything in the first quarter by the weather. We had excessive rain depending on where it was and snow. One of the big indicators that we look at is bidding activity, and we’re seeing strong bidding activity across the Drainage business and also across the Water business. The other thing we’re doing that we talk a lot about is doing a lot on the operational side to drive the cost down there.

Charlie Brown

The residential demand has been somewhat up and down, obviously, driven by the weather. So I think it’s too early for us to say how that will play out for the full year.

Timothy Mazurczak

Okay. And then just for my follow-up. With the U.S. steel supply of 5% year-to-date and prices falling, should this be a short-term tailwind for margins that’s already priced in the backlog? And how should the pricing environment for DIP be impacted for the balance of the year? And how much of an improvement is this for the Drainage segment?

Jeff Bradley

All right. So we use about $100 million of steel in our Drainage segment. We don’t use any steel in the Water segment. In the Water segment, we use scrap, scrap steel. We’ve seen softness both in scrap for Water and the steel for Drainage. But as you know, both of those are cyclical, and I think you’ll eventually start to see them both start to level out. But definitely, both the softness and the lower cost in both of those will help us – typically our inventory. It takes about 60 to 90 days to flow through the inventory. So those softer numbers that we saw coming down in the first quarter really won’t start to realize until about the second and third quarter in the second half.

Operator

Our next question or comment comes from the line of Rohit Seth from SunTrust. Your line is open.

Rohit Seth

Hey, thanks for taking my questions. Just wanted to talk about some of the initiatives that you have in place in the Water business. I know you have some leadership changes there. And then if you can elaborate a little bit on the investments you made in your inventory? You’ve spent some cash on that in the quarter.

Jeff Bradley

Sure. On the initiative side in the Water business, Rich Hunter came onboard last year as Chief Operating Officer, and what really attracted us to Rich was his extensive 30-year plus experience in operations. He’s done an awful lot of work on lean, and we’ve instituted what we call MDI in our plants Managing for Daily Improvement. And what we’ve done is, we have these hourly count boards in all our plants. We have visual control, so the operators know what they’re looking at, what’s ahead of them, what’s behind them. When we miss the target, we’ll document the reasons for the miss and then focus on eliminating the reasons. And what we’ve seen where we have eliminated – I’m sorry, where we have instituted MDI and lean in the plants, we have seen productivity improvements as high as double digit. So it’s absolutely working. Our defect rate in Water has also come down. We thought our rates were high last summer. And again, with all the work that Rich has done, we saw all those defect rates internally continue to drop throughout the year. And it all gets down to just managing the workforce to work smarter.

Charlie Brown

As far as the inventory side, Rohit, we had built up quite a bit an inventory at the end of the year for both Water and Drainage. Obviously, the first quarter demand was somewhat less on the Water side because of the exposure to very wet regions along the coastline. Those would be our strongest markets for the ductile iron business. And so we did not – it did not come down as much as we might have liked. But at the same time, we anticipated a pretty slow Q1. It is first quarter. And so that actually I think the performance on the margins demonstrate some of the results of the work that Jeff was talking about as far as initiatives as well as just – we basically have continued to work to improve this business.

Jeff Bradley

And just to remind everybody that’s new to the company, our first quarter is always the lowest quarter behind that would be fourth quarter then second quarter, and third quarter is always the strongest quarter.

Rohit Seth

And just a follow-up there on the cash flow. Can you help us set the expectations for working capital investment and your CapEx or not?

Charlie Brown

Absolutely. As we had discussed in our fourth quarter, we had talked about a number of those values and we continue to stand by that. We put a presentation out on our website. You can see on Slide 7 – or Slide 8, if you get a chance to look at that. And really the cash flows, we expected working capital benefit of $30 million to $50 million. We expect capital expenditure to be in the range of $45 million to $50 million. And then we had several other items, specifically interest, we have $80 million to $82 million of interest expense for the full year. As a result of that, we generate what we would say is discretionary cash of somewhere between $30 million and $85 million, and we intend to put that towards repayment of the term loan.

Rohit Seth

Got you. Okay. And then last one, any update on April, May, what kind of shipping rates you’re seeing?

Jeff Bradley

I mean as I said, the second quarter is our second strongest quarter. Bidding activity is good, backlogs are good. Pricing is up in both the businesses, and we’ll just keep our fingers crossed on the weather. So far so good.

Rohit Seth

All right.

Operator

Thank you. Our next question or comment comes from a line of Matthew Bouley from Barclays. Your line is open.

Matthew Bouley

Hey, thank you for taking my questions. I wanted to ask about the pricing side, pretty strong in the Drainage business this quarter. How should we think about that for the balance of the year? Should we be kind of thinking about a similar level of pricing that you may achieve on kind of a quarterly basis for the balance of this year?

Jeff Bradley

Yes. For the balance of the year, we’ve gotten a couple price increases this year. In the first quarter, depending on the strength of the markets, we could see a couple of more, the second half of this year. Bottom line is, as we’ve said a couple times, the backlog is strong and the pricing is up in that backlog. And it will take in Drainage – some of that business will go into next year. We’ve got a lot of really good strong infrastructure work. But the bottom line is, we see the pricing remaining strong throughout the balance of the year.

Charlie Brown

I think the key point, Matt, is that we’ve got price because the market – there has been higher input costs, and we are definitely – we’re working to offset that, and I think we’ve been very successful in Drainage, certainly in 2018, and for 2019, we would expect the same for both businesses where we’ll be able to get price that more than offsets that input cost increase that we have been burdened with.

Matthew Bouley

Okay. I appreciate those details. And then on the Water side, you called out some help from, I guess you said, manufacturing efficiencies. Is there any additional color you could add to that? Would – I guess I would just love to hear kind of the – a little bit more about some of the actions you’re taking to improve the manufacturing in Water.

Jeff Bradley

Sure. And I talk about that – Rich came onboard last summer, and I asked Rich as Chief Operating Officer to focus almost exclusively on the Water business, specifically the DIP business. And he’s got a tremendous amount of background in lean manufacturing. And as I said, he’s really put this whole concept of Managing for Daily Improvement in place where people are managing the business every hour of every day. And where we have a misstep, we figure it out, what happened, fix it and go forward. And we’ve seen great, great improvement in all of the plants. Vik is running it now. Vik continues to work with Rich. So we’re really excited about those improvements we’re seeing.

Matthew Bouley

All right, guys. Thanks again.

Jeff Bradley

Sure.

Operator

Thank you. Our next question or comment comes from the line of Nishu Sood from Deutsche Bank. Your line is open.

Tim Daley

Hi, this is Tim Daley on for Nishu. Well, I guess the first one is, Jeff, I think you mentioned that backlogs in both segments were strong with higher volume and price than the last year but then as well you also mentioned that maybe some of that Drainage backlog might leak into 2020. So just first off, did I hear those comments correctly?

Jeff Bradley

Yes.

Tim Daley

And can you help us reconcile those with what should we be expecting for top line growth this year?

Jeff Bradley

Sure. So we take the Drainage backlog – of course, a lot of – not a lot but a good portion of that backlog relates to infrastructure. And as you know, a project on infrastructure whether it’s a new highway, it could be a couple of years. So some of that will leak into the next year and depending on the project – we got a couple of larger jobs in Texas that will actually go out for a couple of years. On the Water side, that 85% of what we sell is sold to distributors, and the backlog there would be shorter term. Water is typically going to liquidate in, let’s call it, 90-plus days. So most of the Water backlog should be out by, let’s call it, the end of the third quarter. Could be into the fourth quarter, whereas the Drainage backlogs, some of that will leak into next year.

Tim Daley

All right. No. That’s really helpful. Hopefully...

Jeff Bradley

And then just on top of that, as I’ve said, the other indicator is, I mean, backlog – a strong backlog is a good indicator. But what’s almost better than that is just bidding activity. What’s out there that we’re bidding on. And I talked to all of the General Managers in Drainage across the country, and every single region that we operate, bidding is up from a year ago. So that’s what really gives us the optimism about the balance of the year.

Tim Daley

Yes. I know that sounds very positive there. So I guess, just then my second question is, we have heard from several companies that operate in similar end markets and regions as you all that there was maybe some push forward of work that was delayed in FY 2018, that was kind of pulled into the first quarter, and then maybe even some pull forward of 2Q volumes because of some regions with exceptional weather. So just curious as were there any kind of one-offs, maybe pushes or pulls that helped you guys support the strong sales growth that you put up in the first quarter of this year?

Jeff Bradley

Yes. I would say, yes. But we really always see that and it’s so dependent on the weather. Whether it’s rain or snow or very cold, but it is not unusual for weather to push business from one quarter to the next quarter. It’s not that uncommon.

Charlie Brown

And I think in our guidance, Tim, we had – when we put the first – when we talked at the end of the fourth quarter, we indicated there would be more push towards the second half. There was carryover from 2018 into the first half of this year, but it’s – again, that would not be in material. The question becomes, when can contractors actually get the work done? So that will drive how much of this gets carried into 2019. How much gets pulled forward to that extent as well. So I think that there is good interest. We have heard other companies talk about this. But I certainly would say, the underlying demand is good. We’re well positioned to service that. And it comes down to – this is Q1, we’ll see how the year continues to play out.

Jeff Bradley

And just add to that, Tim, and I think I try to say this almost on every call, when you look at the companies that people look at as their peers, what really differentiates us is, all of our products go underground. And I’ve said so many times, I’m sitting in my office, I look outside we’ve just had torrential rain for three or four days, it’s a beautiful sunny day, and hey, the contractors are going back to work. But in our business that doesn’t happen all the time because the job sites get flooded and they can’t dig, and they literally have to wait for heat and wind to dry things out. So we’re very different. And there are still job sites today as we sit here in May that are still down from the first quarter because of all the rain. So that’s really the difference in our business.

Operator

[Operator Instructions] Our next question or comment comes from the line of Jerry Revich from Goldman Sachs. Your line is open.

Ben Burud

All right, good morning everyone. This is Ben Burud on for Jerry. To start, can you give us an idea how you’re thinking about free cash conversion in terms of FCF to EBITDA over the balance of the year to get to that $60 million-ish of free cash for the debt repayment. Now, I’m shaking out a conversion around 75%. Can you just give us your thoughts on the visibility – or – you have into the cash flow picture over the balance of the year?

Charlie Brown

Sure. I mean Ben, what we’ve provided as far as our guidance of where our cash intent was for the year was pretty clear at the end of the fourth quarter, and we have not changed that view. So really the big piece for us is we do have a large interest component, which is got to – has got to be paid. Working capital will be the biggest swing. Everything else is pretty solid. Our CapEx spend, we’re talking $45 million to $50 million. Those are specific projects, we’re working on that right now and making sure that we’re investing that wisely for project that will yield good returns. But the actual conversion, just because we are at such – we’re at a level where we have specific needs. We were trying very hard to lay that out for you all. So I think it would be the incremental amount of where the higher end would certainly yield a higher results on the payout. So I think it’s really – that would be where I’d focus your attention as to – if we can start to come as we go through the year to the higher end of our guidance, there would be more cash that would be able to be generated for that discretionary debt payment.

Ben Burud

Understood. And given the strength in public construction spending and the acceleration on bidding activity and projects that you guys have mentioned, can you kind of give us an update on both competitive and bidding intensity for those type of projects? And maybe how that compares to the environment a year ago?

Jeff Bradley

I mean it’s pretty much the same when you look at both the businesses. In the ductile iron pipe business, we have two competitors. In the Drainage business, it’s more of a regional business. But the competitive landscape really has not changed in the past year.

Charlie Brown

I think the upside opportunity for us, Ben, as we’ve talked about several times is the improvement that we have made in the business. So the investments we have made in the various initiatives that Jeff has talked about are very important. The improvement we made as we came out of 2018, it’s a – recall the beginning of 2018, we had a slow start production-wise in the Water side because we had a large plant outage, which put us behind the eight ball. This year, we’re in much better shape. Obviously, we have got strong inventory positions and as the weather permits, the shipments from that division should be much more effective.

Ben Burud

Got it, thank you.

Operator

Thank you. I’m showing no additional questions in the queue. At this time, I would like to turn the conference back over to management for any closing remarks.

Jeff Bradley

Okay. Thank you, everybody. We really appreciate your interest, and we look forward to hearing from you on the next call. Have a good day.

Operator

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