Aegion Corporation
Q3 2014 Earnings Call Transcript

Published: 1 Nov 2014

[Operator:]

Good morning, and welcome to Aegion Corporation's third quarter 2014 earnings call. At this time, all participants are in a listen-only mode. Later there will be a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this event is being recorded. Management has provided a presentation to summarize the financial results and outlook and will reference the presentation during their prepared remarks. The presentation can be found on Aegion's website at www.aegion.com. Any financial or statistical information presented during this call, including any non-GAAP information, the most directly comparable GAAP measures and reconciliation to GAAP results will be available on Aegion's website at www.aegion.com. During this conference call, the company will make forward-looking statements, which are inherently subject to risks and uncertainties. Results could differ materially from those currently anticipated due to a number of factors described in the company's SEC filings and throughout this conference call. The company does not assume the duty to update forward-looking statements. Please use caution and do not rely on such statements. I will now turn the call over to Chuck Gordon, President and Chief Executive Officer of Aegion. Sir, you may begin.

[Charles Gordon:]

Thank you, and welcome to our third quarter earnings call. With me today are David Martin, Executive Vice President and Chief Financial Officer; David Morris, Executive Vice President and General Counsel; and Ruben Mella, Vice President of Investor Relations and Corporate Communications. The financial results in the third quarter were in line with our revised guidance we gave you at the beginning of October. Insituform's North America business continues to have a great year. Commercial and structural performed well in the quarter as the sequential performance for Fyfe North America reports the expected recovery in 2014. We’ve noted the challenges facing energy and mining in the second half with respect to project timing, a greater mix of downstream maintenance and a shift to lower margin construction activities. The fourth quarter is off to a good start and we have the backlog in hand to finish the year within the non-GAAP earnings-per-share guidance of $1.27 to $1.37. I will elaborate more on the steps we're taking to strengthen our planning process that will support the risk-adjusted 2015 earnings guidance we will provide on the fourth quarter and full-year 2014 earnings call in late February. Although we have some work to do between now and then, I believe we have a solid foundation for growth in 2015. The operating performance this year has much improved over last year. The realignment and restructuring effort strengthens the operations going forward while delivering significant cost savings. And I see an overall positive market outlook. Let me turn the call over to David Martin for his perspective on the third quarter results. David?

[David Martin:]

Thank you, Chuck and good morning. Last evening we announced the third quarter non-GAAP earnings per share $0.43 compared to $0.44 in the third quarter of 2013. And keep in mind that last year’s results included approximately $0.11 from earn-out reversals and equity income from the Aegion Corporation joint venture that is no longer part of earnings due to its sale in March this year. On Slide 4, you can see the consolidated revenues grew 13.8% from the third quarter 2013 and non-GAAP operating income increased 6.8%. We’ve outlined the third quarter impact of the realignment and restructuring plan on Slide 5 and our estimate of the fourth quarter and beyond. For the third quarter, we recorded an $18 million non-cash charge for tangible and other assets related to receivables, inventories, fixed and other assets, tax related items and liability accruals related to the shutdown of the contracting activities in certain of the international water and wastewater markets. In addition, we recorded a $22 million non-cash charge related to impairments to fixed and intangible assets related to our Louisiana pipe coating facility. In the fourth quarter, we expect to recognize a large portion of the $15 million to $18 million of cash charge related to employee and lease terminations and other costs related to the restructuring effort. We conducted our review of goodwill for the reporting units impacted by the realignment and restructuring plan and concluded that there were no impairments. As mentioned in the press release, the effective tax rate from restructuring and impairment related charges was 17.3%. it’s important to note that this reflects the non-deductibility of certain of the charges coupled with valuation allowances of previously recorded deferred tax assets due to our inability to recover tax losses as there will be no future taxable income in certain of these tax jurisdictions. We’ve also provided an estimated tax impact of write-downs of certain intercompany loans to the restructured country operations that we do not expect to fully recover. Now the quarterly results met the revised expectations we provided in early October. I like to summarize the non-GAAP results by providing color on our gross margins and performance at Brinderson. Consolidated gross margins were 22.5%, the same as in the prior period as shown on Slide 6. Insituform's North American business generated very strong gross margins, a 100 basis points greater than the margins achieved in the third quarter of 2013 and the highest level since 2010. We met or exceeded our operational metrics, including crew utilization, crew revenue per foot which allowed us to execute the majority of our projects at or above bid margins. A greater mix of medium and large diameter work contributed to higher revenues and better leverage of our fixed costs. As a result, that business delivered strong book-to-bill performance driving mid-teens revenue growth and a 90 basis point increase in operating margins before corporate expense allocations. Fyfe North America and Fyfe Asia performed very well in the quarter as commercial and structural gross margins were 46.2%. We've seen steady improvement each quarter this year in terms of execution and that was again the case in the third quarter as we favorably closed out several projects ahead of bid margins. Our Asian business grew revenues by more than 10% and operating profits increased over 200% to almost $1 million compared to the third quarter of 2013. Gross margins at Bayou were in the teens due to primarily to strong revenue growth in Canada and improved project performance in our Louisiana coating operations. This compares to single-digit margins in the third quarter of 2013. The Louisiana facility completed several small project in the quarter which significantly improved margins and reduced the operating loss by nearly $1 million on a year-over-year basis. Offsetting these sources of margin expansion was a negative mix effects we talked about on our October 6 call at Brinderson because of a greater proportion of downstream refinery maintenance work, along with some start-up costs for the initial project award in the Permian basin. Corrpro margins were down year-over-year as they executed a greater proportion of lower margin cathodic protection installation activities supporting new North American oil and gas pipeline construction. Despite the margin reduction, Corrpro grew revenues double digits and operating income before corporate allocations in the high single digits. Finally, the delay in work releases for United Pipeline Systems and a production slowdown associate with the offshore schedule shift to 2015 or CRTS’ Saudi Aramco Wasit project held back some gross margin leverage in the quarter for the segment as these businesses garner the highest margins for the platform. The second area I like to address is our first year-over-year comparison for Brinderson since the acquisition in July of 2013. On Slide 7, you can see revenues were up 61.3% on the strength of their downstream business through new contract awards on the West Coast and a couple of clients releasing some turnaround activity earlier than usual. Monthly billable hours were at record levels while maintaining high quality performance and an industry-leading safety record. The upstream maintenance segment continues to perform well in California, up 35.8% year-over-year but the impact of the large downstream awards skewed downstream margins versus the higher-margin upstream compared to a more typical 50

[Charles Gordon:]

Thank you, David. Earlier this month we announced a strategic realignment as shown on Slide 9. First, we will form a new operating segment in the fourth quarter Infrastructure Solutions, combining commercial and structural and water and wastewater. This new platform will leverage the market-leading technologies as Tyfo Fibrwrap and Insituform to offer municipal clients a broader portfolio solutions to meet their needs. Fyfe North America will benefit from Insituform’s integrated back-office services and project management capabilities, allowing it to increase the focus on the recovery and return to sustained growth in 2015. We streamlined the management structure, leveraged the depth of the leadership team across the new platform and our geographic markets especially in Asia. Second, we're exiting the CIPP contracting operations in France, Switzerland, India, Hong Kong, Singapore and Malaysia and favorable product sales strategies as you can see on Slide 10. These markets either had difficulties with profitability over the past few years or the market structure no longer supported the sustainable contracting operation. The move to a third-party product sales strategy will reduce earnings volatility and allow for greater management focus in the areas needed to achieve Aegion’s growth objectives. Finally, we are restructuring Bayou's Louisiana facility to position the operations to compete effectively in the Gulf Coast onshore and offshore pipe coating markets through lower fixed costs and higher efficiencies. We expect to realize $8 million to $11 million in annual savings representing $0.15 to $0.20 per share with $0.03 to $0.04 expected in the fourth quarter. We will conclude 2014 with three new platforms

[Operator:]

(Operator Instructions) Our first question comes from Mike Shlisky of Global Hunter.

[Michael Shlisky:]

I wanted to maybe quickly touch first on your decent backlog growth in the water, wastewater segment. Election Day is next week here in the US, can you comment on the nature that you might see to spending at the federal, state, local level after Election Day, are there any kind of races that you're watching right now with the tone on spending on water, and infrastructure might change there. If there were to be a change in the person who is currently in the office whether it's a state or federal?

[Charles Gordon:]

We haven't followed all the election that closely. What we look at is our sales funnel going out over the next 15 months and projects that we see -- that will go to market next year and that’s really the basis that we believe the bid table, will grow to the $850 million to $900 million. Our expectation is that we will not – or that we'll see that growth and that the market will improve next year.

[Michael Shlisky:]

Regarding the -- I want to touch on quickly here. Your comments about the recent declines in the price of oil, it sounds like you said that you’re just kind of assessing how things are going right now, but kind of trying to share with customers, to kind of get some of their feedback, but is there -- have you had any actual specific comments yet from any customers that some projects in the layup in the pipeline sets are maybe delayed a bit. Or is this just kind of where things might go as what you're actually hearing from your current customers?

[Charles Gordon:]

Everything we've heard from customers so far is that all the projects we’re working on it going forward, I want to remind you that the project that was canceled in Q3 was canceled prior to the decline in the oil prices. So that was an independent event but we haven't heard anything from our customers that would vote negatively for next year. Now saying that we also recognize that the price decline has been very recent and they are in their planning process for their CapEx for 2015. So we’re watching it very closely but to date we’ve heard nothing negative.

[Operator:]

Thank you. Our next question comes from Eric Stine of Craig-Hallum.

[Eric Stine:]

Hi everyone. Thanks for all the details on the call. Maybe just starting with Corrpro, I know for some time the focus internally there has been to address the mix issue, the low margin construction business. So just thoughts on I mean clearly that's still a focus, but how you're approaching that differently now maybe than you had been previously and just maybe just some -- on thoughts on when that maybe those initiatives start to take hold?

[Charles Gordon:]

So I guess what I would say is first of all, we’re pleased with the progress Corrpro has made over the last couple of years and what they are doing in North America. I think that as we look at the business, the construction activities with AC mitigation at least the pipeline inspections, at least some of the higher-margin engineering work, so we’re going to continue to do the construction work as much of it as we can. We believe that over time we will see more of the high margin services as a result of our relationship with the customers that we gain while we do the construction work. So we would expect that the business mix will improve over time.

[Eric Stine:]

So more a function of just where a lot of these projects stand than anything else. Okay. All right. That's helpful. And maybe just switching over to the international water and wastewater. Just a reminder on the CIPP business getting out of certain markets when that wind down, you think it's complete, maybe updated thoughts on the amount of business that is and then just how much time you think it takes to ramp up that third-party tube sale business?

[Charles Gordon:]

We've already started working on the third-party tube sales and in several of the markets, some of the key competitors are very interested in buying tube from us as a result of us no longer being a competitor with them. If we look at the -- as we look at the backlog in the business we’ve got about $17 million of backlog in Asia Pacific and what I would expect is that we would wind a significant portion of that down by the end of Q3 next year. There may be a bit of a tail on that but most of it will go through over the next nine months.

[David Martin:]

Eric, just as a reminder too – this is David -- a good portion of that backlog is still Australia as well. So there's not a tremendous amount of backlog remaining in those markets that we’re exiting.

[Charles Gordon:]

Just to be very concise -- we would expect that most of the markets that we’re exiting in Asia we would work off the backlog over the next nine months – 9 to 12 months.

[Eric Stine:]

And same thing in Europe?

[Charles Gordon:]

Yes.

[Operator:]

Thank you. And our next question comes from Glenn Wortman of Sidoti & Company.

[Glenn Wortman:]

Just for some context, what percent of your energy amount of revenue is derived from work on new oil pipelines? –

[Charles Gordon:]

That’s a great question. What I want to start with is as we look at the business – let me start it with a broad picture and then work down to question. As we look at the business today, almost 50% of the business is non-energy related with infrastructure solutions, I think 45% of revenues this year will come from non-energy work. So it's a split market and that’s one of the benefits of the diversification strategy. As we look at the energy piece, about 60% to 75% of the overall business is maintenance related. The remaining portion is new construction and what we’re working through right now as we go through the planning process is of that remaining portion, it’s new construction, how much that is gas transmission and how much it is oil pipeline and I don't have that number yet. We’re certainly going through that as we do our planning for next year. But as you can see from the overall answer it’s a relatively small portion of the business that's related to midstream oil pipelines.

[Glenn Wortman:]

And then with respect to the $70 million to $80 million in pending maintenance contract renewals at Brinderson that are up for bid here in the fourth quarter. Can you just talk about how you're positioned to perhaps win that work and then -- and how much in contrast, will have to be rebid in the fourth quarter of next year as well?

[Charles Gordon:]

So I will take the first one part of that question. Of the $80 million in renewals we feel really good about those, we’re in contract discussions with customers. We expect those to occur between now and the end of the year, now obviously they are not booked yet. But we feel really good that they will be renewed. And just to remind you, although the renewals are worth $80 million we also will be working off of some revenue, so sort of the net about 75% of those renewals will result in a net increase in backlog. I don't have the answer on what works are or what comes to [terminal] the next 12 months, maybe David does.

[David Martin:]

Yes, well, there's nothing as significant as what we’re seeing in the fourth quarter this year. These are two major upstream customers, they are long-standing relationships and they haven’t – they’re coming up through for renewal this year. We do have renewals on much more limited basis as we go into next year but nothing like this.

[Operator:]

Thank you. Our next question comes from Arnold Ursaner of CJS Securities.

[Arnold Ursaner:]

Chuck, my first question for you, is there any change in the direct reports that you deal with, with the change in the reporting?

[Charles Gordon:]

I think change, Arnie, is that on the operating businesses we reduced from Fyfe direct reports to three operating presence. And so I guess there is a more focused operating line from my perspective but across business there really isn’t any change in direct reports. I think you may know Brian Clarke who was our corporate development person left in July and the Fyfe business now reports into Tom Vossman but those two things happened in the third quarter. But there are no changes in my direct reports.

[Arnold Ursaner:]

And my second question, I know we mentioned this when you had your Analyst Day in June and you and I spoke after the meeting. I know you have a tough business, you are impacted by customer timing and a lot of other issues that frankly are out of your control. But I guess my question for you and maybe it's one for your Compensation Committee of the Board, but Chuck, are you trying or attempting to align the entire executive team compensation to meeting whatever disclosed public goals you give your shareholders, encouraging all including you to under-promise and then over perform?

[Charles Gordon:]

Let me answer that this way. What we've had in place is our incentive plan is absolutely aligned with increasing shareholder value. What we haven't had in the past is the portion of that plan, either forecasting accuracy or meeting guidance. Now to be honest, guidance is always based on budget and so from that perspective it was certainly linked. As we move into 2015, David Martin, David Morris and I are spending a lot of time looking at the incentive plans and making sure that they drive our behaviour and certainly guidance is the aspect of that.

[Operator:]

Thank you. Our next question comes from Spencer Joyce of Hilliard Lyons.

[Spencer Joyce:]

First one perhaps for you, David. The gross margin at the commercial and structural segment at over 46% this quarter was just phenomenal. I want to say that the best we've seen in six or seven quarters. Can you talk a little bit about the drivers there? That's still a little bit of an anomaly that you have one particularly good project or perhaps some of the realignment initiatives taking hold just how can we think about a run rate here or sequentially think about that metric?

[David Martin:]

Well this quarter’s performance was exceptional, it was much higher than what we anticipated. We did have some favorable close-out to some jobs in the US. We had some mid-performance in the Asia-Pacific market as well. I still believe that the normal run rate for margin is 35%, maybe a little bit better range but that's more normal for it. But we did have really good performance this quarter. The bid margins that see and on work that’s in the funnel as well as backlog now is more in that normalized range.

[Spencer Joyce:]

Okay. So I guess kind of on balance would be this quarter as a little bit of an anomaly rather than kind of the new norm?

[David Martin:]

I wish it was the norm but it’s sometimes dependent upon the mix of work that we have as well as it’s pure pipeline construction or primary pipeline work versus the other verticals as well. But this was really more about really good favorable close-out for some big jobs.

[Spencer Joyce:]

Shifting over to the backlog a little bit here. I thought you all may have alluded to it a little bit in the prepared remarks, but as we think about the dollar amounts in backlog now. Is that a more resilient figure than maybe we would have seen a year ago at this time? Is there already a more conservative stance baked into what you all are accounting for and putting out there for us?

[Charles Gordon:]

I don't -- this is Chuck -- I don't think so. I think we’re obviously very careful about what we put into backlog to make sure that we’ve completed the negotiating process with customers on all the terms. But I don't think that that we have -- that we've added more conservatism to it.

[Spencer Joyce:]

And then sticking with the backlog. If I'm adjusting correctly it actually looks to me like the energy and mining number ex-Brinderson was up sequentially, if we adjust for that $34 million cancellation. I guess first, is that correct and then, if so, can you talk about some of the drivers of that advance because I think as a couple of people had mentioned we're all expecting a little bit subdued CapEx outlook kind of over the next few quarters and just kind of true up those items for us?

[David Martin:]

This is David and I will take it and Chuck can add on. Yes, it was sequentially up -- two principal drivers, well it’s up, with the exception the cancellation. The two drivers -- backlog at Corrpro continues to be at record levels and it has sequential improvement, and we also did have the additional new awards for the CRTS business both in South America and in the Middle East. So and then most of the other businesses around it were more normalized and not much changed, so those are two nice drivers for the business because obviously Corrpro is a strong fundamental business bedrock for the corrosion prevention business. And then CRTS carries really nice margins and it's a good onshore work that we’re operating in with two major clients.

[Spencer Joyce:]

And then sticking here with the backlog, I was really surprised to see the Brinderson backlog up really just pretty slightly from the year-ago level. And I know you all addressed that there is a couple of three potential awards out there that could be worked into that number. Should those not come to fruition, would it be safe to say that we would see either a revenue decline for Brinderson or perhaps some margin compression, it's just without the growth or much growth in backlog there at this point, it would be tough to sustain and kind of, in my mind, the revenue gains that we saw this year?

[David Martin:]

First of all, these renewal – we are very confident about those renewals, they are long-standing clients, they are in the final stages of negotiation. And so I am not anticipating that we’re going to have any decline whatsoever here. We also have continued work with the existing client base on other opportunities. So I guess my answer is no.

[Spencer Joyce:]

So you do -- so the Brinderson backlog at this point at $2.19 is a bit of an anomaly to the downside –

[David Martin:]

Yes, mainly because these renewals are so significant and we don't normally have renewals – I mean these are pretty -- the two largest upstream clients that we have and they just happen to be following into the fourth quarter this year. So I fully expect that you’re going to see a nice backlog number at the end of the year and it'll be much more normalized next year because I don't believe we have any major renewals next year.

[Spencer Joyce:]

One final kind of big picture question and Chuck, you kind of touched on this with the last caller and when you mentioned Brian Clarke's departure back in July. But can you just kind of broadly comment about that the corporate morale there over the past month or so, kind of as you go through and start to roll out some of these restructuring or realignment initiatives? And then maybe specifically, have you seen any voluntary departures among, call it, your top 10, 15 or so operational managers?

[Charles Gordon:]

We have – there are couple of things, first, I am just going to sound maybe a bit self-serving but I would classify the overall morale at the corporate level and at the operating level is extremely good. I think we’ve resolved some issues that have been out there for a while with the restructuring. I think the management team was in complete agreement that we needed to take the actions that we took. And I would say the overall operating margin is – I am sorry - the overall morale at the corporate and at operating groups is extremely good, no issues at all. I would also say that with the – Brian Clarke left, certainly we would have liked him to stay. That was the decision that he made. We’ve lost a couple of other people that I think were partially a result of the transition. We didn't lose anybody on the operating side and I think going forward we have a very stable -- very stable management team.

[Spencer Joyce:]

You said, of the couple of departures, few on the operating side or none on the operating side?

[Charles Gordon:]

None on the operating side.

[Operator:]

Thank you. And our next question comes from Steven Folse of Stifel.

[Steven Folse:]

First question is on the 30 million and awards in CRTS in Chile and Middle East. Can you talk a little bit more about the timing of when you should see the benefit from those? And then also the nature of the contract, are these similar to like the Wasit pipe arrangement where you’re sub-contractor in a larger contract or can you just talk a little bit more about that?

[Charles Gordon:]

It’s a mix. We are typically working for a contractor. The projects are onshore and I think we've got – and we continue to build relationships with the contractors in the Middle East and in Chile to make sure that we can be a – we have as much visibility as we can with the customer. But they are onshore projects we have. We've already started several of them. We’ve been very careful of how we projected them for the rest of the year and then we’re also looking at timing for next year as we execute.

[Steven Folse:]

Okay, great. I guess then moving to Bayou there is pretty nice performance in the quarter, but you've kind of alluded to some under-utilization issues in the fourth quarter because of the project cancellation. But I think that project was scheduled to go into 2015 as well. So are you kind of expecting some under-utilization kind of in the first half of 2015 as a result of that project move and then also just some general trends within the offshore market -- I think we saw large offshore exploration projects just get the approval. Are you seeing any sort of benefit there from a recent developments?

[Charles Gordon:]

So there’s a couple questions, let me try to answer them. First of all, certainly the cancellation -- the suspension of the onshore project will impact that business’ performance next year. What we did going as part of the restructuring is significantly reduced the breakeven point of that business. So we’ve significantly – we will significantly reduce the fixed cost in the business and we also with the restructuring are making the plant more efficient. So what we see -- what we’re preparing for is that we build that business out next year without any of the large offshore projects. We have a line of sight on some projects -- that we have with one project in backlog, we have a couple of other projects that we feel really good about, they’re smaller projects. We expect the business to be profitable next year but we are not betting on any of the large offshore projects. I think that particularly with the current oil price environment and the timing of an investment of that size, there’s just too much uncertainty there for us to plan on those occurring. So we’re taking a pretty conservative approach as we look at the business. We haven't heard anything from our customers about offshore projects being postponed or anything like that. But again I think it's too soon to tell, I think as we get into next year and they go through their planning process we will learn a lot more. Bayou Canada is in great shape. We've had a lot of orders go into the winter construction season, we are yard full of pipe, we’re very pleased with where that business is at and we look forward to that continuing. One of the comments I want to make is certainly the Bayou business is a business that is susceptible to prolonged lower oil prices. It's new pipelines that's the core of the business but in Canada, our Bayou business isn’t built around the tar sands, or the oil sands. I want to be clear on that it's around the more traditional oil. And that business continues strong and we haven’t got any input from customers up there that they have issues with the current oil prices. But again I just want to emphasize it’s early. So does that answer your questions?

[Steven Folse:]

That was helpful. Thanks. And I guess lastly here considering the large global reach of your company. Can you talk about on any impact that you saw in the quarter from the strengthening of the dollar? And then kind of moving forward how are you anticipating any other potential impacts from that?

[David Martin:]

Certainly the strengthening of the dollar – it does have some foreign currency fluctuations and we saw some foreign currency losses that hit the bottom line. But we are very careful to manage cash flows in and around those to make sure that we hedge properly but as far as any real volatility it’s not significant for us.

[Charles Gordon:]

And so a lot of the businesses are sourcing and doing their work in local markets and that shields them from sort of a higher dollar importing if they’re trying to import things from the US into those markets and I think we’re pretty shielded from that is based on the nature of the business we tend to source most of the product side that what we sell outside the US.

[Operator:]

Thank you. Mr. Gordon, at this time I am showing no further questions. I like to turn the call back over to you for any closing remarks.

[Charles Gordon:]

Thank you. I really appreciate everybody being on the call. I'm very excited about the business as we move forward. I think we had a nice quality of earnings this quarter. We expect to hit our full-year guidance as we expressed on October 6 and moving into next year, I think the business is positioned reasonably well to grow organically and meet its promise that we’ve made over the years. We are watching oil prices very carefully and as we go through our planning process we’re assessing all of our markets and making sure that we really understand where the growth is coming from and what investments we need to achieve that growth. But we’re not done with the planning process yet. We’re in the midst of it but I'm optimistic based on what I am seeing. That’s what I would leave with. Thank you for joining us today.

[Operator:]

Ladies and gentlemen thank you for your participation in today's conference. This concludes your program. You may all disconnect. Everyone have a great day.