Forterra, Inc.
Q3 2018 Earnings Call Transcript

Published: 10 Nov 2018

[Operator:]

Good morning and welcome to Forterra's Third Quarter 2018 Earnings Conference Call. Today's call is hosted by Jeff Bradley, the Company's Chief Executive Officer; and Charles Brown, the Company's Chief Financial Officer. With that, I will now turn the call over to Mr. Brown.

[Charles Brown:]

Thank you and good morning to everyone. Welcome to Forterra's Third Quarter 2018 Earnings Conference Call. Before delivering -- giving the floor to Jeff to deliver our keynote, I will 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 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 everybody. Thank you for joining us on the call this morning. The end market fundamentals and the demand for our products are strong providing solid backdrop for us in driving improvement in our business. We continue to be pleased with the performance in Drainage, which would have been even stronger had it not been for significant rainfall in Texas, the Midwest and Eastern part of the U.S. We had organic top line growth and higher margins as a result of our purchase and our ongoing focus on driving down the cost. Our continued optimism about this business is supported by good end market demand and improved bookings trends that reflect higher year-over-year volumes and prices. I'm also very pleased to report a continuing top line earnings growth in our Bio Clean business, which we believe will have even better results next year. Turning now to the Water segment. As discussed on our last call, we made some significant organizational changes focused on improving the business. Early in the quarter, I asked our Chief Operating Officer, Rich Hunter, to head up our Supply and Pipe operations drive operational improvements and Vik Bhatia to head up our Commercial team. These two guys have been working closely together and as a result of numerous initiatives they have implemented, we're seeing higher prices and lower cost now falling into financial support of our guidance for the fourth quarter and expectations for higher margins next year. Turning to our demand outlook. We see strong demand for our products in both segments across all of our end markets. Private side demand including residential and commercial remains very good. The outlook for infrastructure demand is strengthening supported by improving state and local level funding in many of our key states, including Texas, California and Florida. Conversations with the customers and review our projects that are planned led an underway supports our positive outlook. In summary, I'm really pleased with our grand results this year and encouraged by improving operational and commercial performance of our reported segment. We feel really good about the current market demand environment and we expect better results next year. Charles?

[Charles Brown:]

Thanks Jeff. In the third quarter, we reported net income of $6 million and adjusted EBITDA of $52 million. Our results for the quarter were at the low end of our guidance due primarily to the estimated $5 million impact from rain. As I'm new in Texas, I hope that the extraordinary amount of rain we received in the DFW market in September and October will not be seen for another 100 years. Sadly, the North Texas deluge was only part of the significant weather events, which seemed to target a number of our key markets. In Drainage, organic sales grew 2% over the period on the benefit of higher selling prices that more than offset the decline of shipments due to weather. We generated higher gross profit, and our adjusted EBITDA margin for the quarter increased to almost 23% and year-to-date is 380 basis points better than the same period last year. We're pleased with this progress and will remain focused on offsetting input costs durability in the coming year. In Water, we delivered organic sales growth of 3% due primarily to growth and shipments as our ductile iron pipe facility is operated at effective capacity to meet strong customer demand. As Jeff said, Rich, our COO, is driving increased efficiency in operations and our commercial team is working to recapture margin lost due to higher scrap, labor and freight costs. Well, our gross profit and adjusted EBITDA margin for the quarter do not yet reflect the benefit of these changes, we saw movement in the right direction over the course of the quarter. We have much work ahead of in this segment but look forward to reporting on our progress. In Corporate, adjusted EBITDA losses of $30 million were below the same period last year and below our guidance range. The improved year-over-year results primarily reflect the benefit of lower professional fees and certain costs and accrual adjustments. With regards to the balance sheet, we ended the quarter with $30 million in cash and no outstanding balance on our $300 million revolving credit facilities. We're pleased that we are able to remain undrawn on this facility year-to-date and expect to build our cash position through the end of the year and the benefit of the usual seasonal working capital trends from the fourth quarter. Turning next to our forecast for the fourth quarter, we expect a net loss in the range of $15 million to $18 million and adjusted EBITDA in the range of $30 million to $35 million. In Drainage, we expect that our results will be impacted by significant shipment delays already realized in October, including record rainfall in Texas, Hurricane Michael in Florida and the carryover effect of Hurricane Florence in our CP&P joint venture. In Water, we expect adjusted EBITDA to be in line with prior year quarter of $18 million, on the benefit of higher selling prices and improved operational efficiency, consistent with our improving performance metrics. Corporate adjusted EBITDA losses are expected to get about $15 million well below the $21 million realized last year. Extreme wet weather has played a significant factor in our third quarter results and our outlook for the fourth quarter. In September and October available shipping days were significantly impacted in key markets like Texas, Florida and the Midwest. As the flow of work has not been dampened by the weather, this has only strengthened our backlog. We are pleased with the improvement we have delivered this year in Drainage and Corporate, and we believe that we are well positioned to demonstrate significant progress in Water beginning in the fourth quarter. We are optimistic about our ability to drive improvements in 2019 against that backdrop of strong market demand fundamentals, and we look forward to updating you on our progress in the coming quarters. That concludes our prepared remarks. Operator, will you please open the line for questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Scott Schrier with Citi. Your line is open.

[Scott Schrier:]

And nice results especially in terms of the environment there with the weather. Can you just talk about after the weather impact? And I know it takes a little while for the ground to become conducive to laying pipe and such. Are operations back up and running what are you kind of seeing in terms of lingering weather impacts? And I guess how is that incorporated into your 4Q guidance?

[Jeff Bradley:]

Thank you, Scott. Appreciate the comments, this is Jeff. All our plans are back up and operating, we got hit really hard in the Pan Handle of Florida. Two of our plants were down in October. Our guys did a phenomenal job in getting them back up and running. So, I'm pleased to report everything is running. We had another record rainfall in October. We talked about that a little bit, that will impact our results third quarter. But outside of the record rainfall, October things are going as planned.

[Scott Schrier:]

Great. And then, the Water segment seems like you're making some progress there. And I'm curious you talked about positive trends in all of your end markets. It seems like we're hearing a lot of talk in residential slowing, and particularly in some of the markets where you're in. Are you seeing any signs of resi slowing and impacting the demand outlook in Water?

[Jeff Bradley:]

So let me just say couple of things about the resi market. First of all I think we all know the resi market today where it stands is still well below to where our average is. We believe pent up demand still exceeds supply. We see residential up in our Texas market, California market and the Florida market. And we see that more than offsetting maybe under a smaller phase where the resi might be off. At the end of the day we're optimistic about the resi business going into next year. Commercial business is good, infrastructure business is good. So again we're optimistic about going into next year.

[Scott Schrier:]

Great. And one last one. What are you seeing in terms of freight and cost inflation are going to freight side?

[Jeff Bradley:]

Freight has backed off to some extent it's loosened up a little bit. Where we really have an opportunity in freight is into ductile iron pipe business. Demand has been strong and right now we're building inventory so that we have the ability to use more rail versus truck. And that will help drive our cost down.

[Scott Schrier:]

Thanks a lot.

[Jeff Bradley:]

Trains really haven't had, trains haven't had really any issues getting trucks typically, a typical truck run is probably 50 to 100 miles, but again the Drainage guys did a really nice job of all cutting those additional costs with higher pricing.

[Operator:]

Thank you. And our next question is from Ian Zaffino with Oppenheimer. Your line is open.

[Mark Zhang:]

This is Mark on for Ian. Thanks for taking our questions. So good quarter and it's great to hear you guys are starting to take price on the market. But can you speak to some of the customer sentiment on price increases and how much confidence you guys have going forward to pass more through?

[Jeff Bradley:]

Sure. So, we break both the businesses down on the Water business about 85% of our sales go through distribution. And the distributors will typically take our price and just mark it up. So the distributors have accepted our price increases. On the Drainage side, just the opposite of that, about 85% we sell direct to contractors. And I think we have done a really good job communicating all default inflation that we've experienced. On the Drainage side, we see inflation on steel, on cement. On the Water side, we've seen inflation on scrap prices. So at the end of the day, when you look at customers, the backlog to the customer base is up, and they've really accepted the increases, understanding our costs have gone up and they have a lot of business.

[Mark Zhang:]

And then since you mentioned that can you I guess go a little bit more into details on expectations for some of the key raw cost trends, particularly scrap and how that's trending and, the fourth quarter and going to 2019? Thanks

[Jeff Bradley:]

Sure. So just to update everybody, the scrap is what impacts our ductile iron pipe business. Scrap moves every month and scrap is really a function of US steel demand and export demand. Scrap was rising almost every month this year into this summer, started to fall off in the third quarter, and now we're seeing it inch back up again, inched up in October, November, we expect prices to be a little bit higher as well. That's why we've going to continue getting higher prices but scrap is all over, it goes up and down. So it's very difficult to predict where it's going to be priced every month.

[Operator:]

Our next question is from Mike Dahl with RBC Capital Markets.

[Mike Dahl:]

I wanted to start with a question around Water and just with the transition and leadership there. A few months in, I know you've laid out some of kind of what needs to be done there? But just curious if you could give us a little more flavor on, as Rich has gotten deeper into that business, what are some areas where he's found kind of other incremental opportunities or potential incremental challenges versus some original expectations?

[Jeff Bradley:]

Okay, So Rich, Rich has a lot of experience. We've really hired Rich based on the background he had. So he's got a couple things, on the production side, we have gone to longer runs and less changeovers, much stronger focus on defects. We've seen defects coming down every single month. Probably most importantly, it's just a culture of continuous improvement and accountability. He has really stressed that, communicating with everybody. So I would say they would probably be the three biggest areas. None of the things that we've seen anything so far just that would say there is any impediment to his actions. The team is very much aligned behind him and working together very well. So I mean that's part of the positivity that we have been able to express hopefully with in this release is that we've got the underlying demand, and we've, operationally, we see good improvement. That's for both sides of the business, but specifically, in the Water area where we see the most opportunity available.

[Charles Brown:]

Yes, absolutely.

[Mike Dahl:]

Okay, thanks. And yes, 4Q, if goes according to plan should mark an important turning point there. It sounds like my second question, just going back to the weather impact around guidance. Obviously it's part of your guidance for 4Q, but I think here if you called out a specific number, you mentioned $5 million in 3Q I think. But is there any quantification you can provide for what you think the headwinds embedded in the 4Q guide are?

[Jeff Bradley:]

Sure Mike. Obviously we did not put any specific weather impact in fourth quarter because it's still to be determined. October is a big month in the quarter, it's probably one of our biggest months of the year just to go through the number sitting there and just how the seasonality of our business works. But December would be very similar. So as I look at the impact for Q3, it probably will be similar until we know additional impact in Q4. So we have to be careful because we got an early winter, we've could a very nice Indian summer. And that is one of the things that we have guided you around, but nothing more specific than that at this time.

[Mike Dahl:]

Okay got it. But I guess than maybe just sneaking in a follow-up qualitatively relative to what you're seeing in October to your U.S. comment there. Are you currently assuming that things normalize in November and December or is there a bit more cushion built in?

[Charles Brown:]

No we're normalized. And again November has Thanksgiving and it starts to get cold especially in our Northern operations. And December has Christmas and it's cold in most of our operations. So it just, they are less impactful. So we try to impact, we are definitely impacted most heavily by the October results which while we haven't finalized we do know the shipping impact for the month.

[Operator:]

And our next question is from Rohit Seth with SunTrust. Your line is open.

[Rohit Seth:]

So, there are questions that were going to ask. In the Water business, looking for guiding to sort of flat results in the fourth quarter.

[Jeff Bradley:]

We cannot hear you Rohit, the connection's bad.

[Rohit Seth:]

Hey can you hear me now?

[Jeff Bradley:]

Yes we can.

[Rohit Seth:]

So, in the Water business thus in the release you're guiding to flat performance in the fourth quarter. Is that a reflection of the maybe the easy comp that you have on snap prices or…

[Charles Brown:]

We can't hear you now Rohit.

[Jeff Bradley:]

Rohit, you're fading, we can't hear you.

[Rohit Seth:]

I have to circle back in the queue. Thanks.

[Charles Brown:]

Okay.

[Operator:]

Our next question is from Matt Bouley with Barclays. Your line is open.

[Marshall Mentz:]

This is actually Marshall Mentz on for Matt. I wanted to go back to a comment in the prepared remarks on Water specifically. And correct me if I misheard that. I believe you said you've operated at capacity in the quarter. Did I hear that correctly?

[Jeff Bradley:]

Yes, Marshall, we're expecting we're operating at effective capacity. So while there is nameplate capacity, there is effective capacity which is what you can actually mean. And so, we are we have done a lot of great work there and that's really where Rich has been very successful and the team on continuing to find ways to enhance our ability. But the underlying demand is great. And that has necessitated us to run everything we can and be as efficient as we can. And we're really we're running up against what our factory can produce at this time.

[Jeff Bradley:]

Yes, I think the key word that Charles just said was, at this time, with all the work that Rich is doing we definitely have a higher production plan for next year as all these improvements happen. So we will continue to keep you guys updated on the improvements and the higher production that we expect to get out of the facilities.

[Marshall Mentz:]

Okay. So it sounds like you're potentially doing some work within your network that maybe has capacity down now but be available next year?

[Jeff Bradley:]

Well. That's right. And we want to suggest that we do have a plant, that we do have idles. We are not intending to restart that this time. Right now, it really is the plan itself, had a limited amount of capacity, the size we've put in at the cupola, the churn we have on the captive machine, all these things have been designed for a less demand intense environment. As this has ramped up and we've seen real pick up from our customers, we've been able to work more effectively with our teams to get greater tons per man hour and going through the existing facilities and adding additional capital where prudent.

[Marshall Mentz:]

Okay, that's very helpful. Maybe expanding on that and looking at the broader industry, can you give us a sense where you think industry capacity utilization stands and if there have been any major shifts in that recently?

[Jeff Bradley:]

Just don't know. I mean, we just really can't, we can't really speak for anybody but ourselves. I mean I can tell you that the name is wrong, the lead times within the industry have moved up. So, I mean, there are all very good size.

[Operator:]

Our next question is from Nishu Sood with Deutsche Bank. Your line is open.

[Tim Daley:]

Hi, this is actually Tim Daley for Nishu. Appreciate the question. So I guess my first one is, it seems like there were solid progress working down manufacturing costs in the Water segment this quarter, but just wanted to dig a bit there's some language around the progress just ramping up in the press release. Just I just wanted to understand that better, or how are we supposed to interpret that may be the full benefit that's expected from this progress wasn't fully recognized in the quarter? And then how should we think about incremental upside from further progress next quarter or next year?

[Charles Brown:]

Sure. Tim, I would say, the comment there is, Rich started in that role only halfway through the quarter and there's a lot of learning and progress to be done. I understand the manufacturing cost, well, for example, if you look at the margin in total for Water and it was down significantly as you know and our delivery on the EBITDA was significantly hampered compared to last year. So I guess, the point we're trying to make is that we're, the operational improvements are coming through. But they, obviously, were not realized during the quarter in the delivery of the earnings that we had. Does that help you understand where we're coming from?

[Tim Daley:]

Yes, I know that, that does help out a lot. And just, I guess to follow up on that. So the Water at 3% organic sales growth, so, obviously it's tough to parse that out, but is there any way we could split that by volume and price? And then as well, how much did the DIP business grow on a year-over-year basis?

[Charles Brown:]

Well, I'll start with the majority of this is DIP. Yes, that is the biggest part of our Water division. And, that is, that's a crucial component which, that is growing and as Jeff had indicated, we've got the good demand which we are able to deliver to our customers going forward. As part of the breakdown, we're not providing that details this time. And that for us given the competitive nature of the business and the environment that we're a public company and we're now also listen due to this conversation I want to make sure that we're being as prudent as we can going forward.

[Tim Daley:]

Understandable, all right. And then the second question kind of moving on to the Drainage side. So solid performance on the SG&A, And commentary seem to allocate much of the benefit over to the Drainage I guess segment. So how much did SG&A percent improve on a year-over-year basis I guess as a percentage of segment revenues? And were there any onetime impacts to the quarter?

[Charles Brown:]

Yeah we haven't broken SG&A out by segment at this time. Although I think it's a great opportunity. And total SG&A has improved significantly. And we don't allocate that to the segments as fully as we could. So I would say just in general the costs have been reduced and all of it comes to efficiency kind of focused on pulling out unnecessary cost. And going forward, I can see that being at said areas that we would like disclose a little bit more. So we can clarify how our costs are coming out. But as we pull SG&A we're going do great deal of professional fees as we achieve that as we look at corporate segment where we broke that up.

[Operator:]

Our next question is from Jerry Revich with Goldman Sachs. Your line is open.

[Ben Burud:]

This is Ben Burud on for Jerry. Along the same vein, I was just hoping you can provide a little more granularity as to how you're getting more comfortable with improved price cost in water? Going forward you called both times in the press release obviously was this more weighted to pricing versus improved efficiencies. And can you kind of give us an update on the pricing outlook specifically how is the pricing shaping up in 4Q and the early part of 2019?

[Jeff Bradley:]

Sure. I think the most important thing to stress here is we have, we've gotten all of the older pricing older orders out of the system. I think on the last call, I talked about having to flush all of those old orders out. The good news is all of that is out now, and we're seeing a true reflection of where the current market pricing is. In the third quarter, that didn't happen at the beginning of the quarter. So we still have some of that lower pricing on the books. But you will see all of that out in the fourth quarter.

[Ben Burud:]

And then do you guys have any pricing action on the horizon near term?

[Jeff Bradley:]

We don't have any planned pricing action between now and the end of the year. We'll have to see how the market goes and if the market continues to be strong and there is an opportunity to raise price to offset our costs. Then we're going to do that.

[Ben Burud:]

And then just touching on freight inflation, can you remind us the breakout between your spot booking versus contract booking. And what size headwinds if there any you're embedding in your 4Q guidance versus 3Q?

[Charles Brown:]

The majority is our freight in contract. And we really, we should be seeing some increases during the year as Jeff said earlier very efficient on the Drainage side that’s in, that’s a good. On Water side, we have struggled more because we had extra demand and we had that first quarter outage that left us a little bit less logistically structured that we would have liked. So we had use lot more trucks than we would normally use more rail. So I think that has positioned us well. We are going into the fourth quarter, as Jeff said, we’re operating at effective capacity or building some efficient inventory to deal best with our customers on the Water side and I think that the slow down during the rain we are still able to produce in most of our facilities. And so we were able to position ourselves pretty well, satisfy customers going into the fourth quarter and be more efficient with our rail and our shipments in total.

[Operator:]

[Operator Instructions] All right, I’m not showing, I’m sorry. We do have a question from Josh Eisenberger with Oz Management. Your line is open.

[Josh Eisenberger:]

Just I guess one more follow-up on the scrap steel pricing and then if I may, on the competitive landscape. So on the scrap pricing, I heard you mentioned that, we kind of scrap pricing kind of came down in Q3, and then it kind of elevated a little bit. But I think, when I look at it, and I’m not seeing the exact pricing that you’re seeing, but when I look at it for the metrics that I track, it kind of feels like you’re probably not yet all the way back to the peak in Q3. And as a result I would think as long as we don’t continue to elevate materially from here hopefully the price increases that you’re pushing through should, I guess hopefully eventually kind of catch-up and maybe that’s why we’re, your guidance history year-over-year EBITDA to be flat does that indicate like we’re actually kind of catching up on pricing?

[Charles Brown:]

Yes. I mean that’s the goal, the goal is always to offset our calls with pricing or production improvements. You’re right, I mean scrap was up, scrap then went off a little bit now it's heading back up again, just to reiterate, the goal is to be able to cover those additional costs with pricing.

[Josh Eisenberger:]

How much of this outside something we’re trying to note down here like outside of the obvious steel price headwind. There is, have you guys seen any impact from the Chinese tariffs or any of the bickering with Canada or Mexico? Has there been any other impact outside of obviously the derivative moves in steel up and down?

[Charles Brown:]

No. I mean, you’re right, the impact is just been the price of steel. We’ve seen significant increases and when we talk steel, we’re talking Drainage, wire and rod. We’ve seen significant increases this year. We’ve done a good job with pricing and we'll offset those increases. But the market is tighten up for steel we're also busy, that’s imports are down and that’s what really driving the prices of steel up.

[Josh Eisenberger:]

And your end users whether that be a residential home builder or municipality using your product for Water or Drainage, they see that, they understand that and for the most part they’ve been willing to obviously you're not, you may not get 100% of it. But you're able to get some amount of price appreciation as a result of that. Is that correct?

[Charles Brown:]

The goal is get 100% of it and let's just break it down again. On the Water side, it's steel scrap. And on the Drainage side, it's steel. And both are pretty much moving hand in hand.

[Josh Eisenberger:]

Right. And your customers, obviously your customers see that they understand that. And when you submit a price increase, it's not like you get like this massive blowback like you are trying to take margin from them. It's, guys that's the price of steel and the price of scrap and there is not much I can do about it.

[Jeff Bradley:]

Right. And then I think the management team has down a really nice job communicating with the sales force and we're out, we're out there all the time communicating and educating the customer on what's going on.

[Josh Eisenberger:]

Okay. And then just so, and the second part of my question was on competition. So if you could just comment both, so first of all on the Drainage business, I know we're kind of like multiple quarters now post the restructuring of the competitive dynamic in the Houston market with the Thompson family. So maybe if you can kind of comment on what you are seeing, obviously, demand is good. The Drainage business is good. What are you seeing on the competitive environment in Houston and more broadly? And then secondarily always headline for us is that there seems only be three guys in the DIP market. And it kind of feels like everybody should be seeing the same thing and everybody should be pricing accordingly, is there anything going on the competitive side and the DIP market, that would prevent you guys from getting price or maybe has that actually normalized and that's enabling you to get price?

[Jeff Bradley:]

Well, all I can tell you is that we have been able to get price, I think we've talked about that today during the call. We've gotten price in DIP, we've gotten price on the Drainage side. I'm not going to address a specific city. We compete with people in every single region on the Drainage side, it could be three, four, five to seven or eight people, it all depends on the market.

[Operator:]

Thank you. I'm not showing any further questions. I'll now turn the call back over to Jeff Bradley, CEO for closing remarks.

[Jeff Bradley:]

Thank you, folks, we really appreciate your interest, and we look forward to the next call. Take care.

[Operator:]

Ladies and gentlemen, this does conclude the program. You may now disconnect. Everyone have a great day.