GCP Applied Technologies Inc.
Q4 2020 Earnings Call Transcript

Published: 4 Mar 2021

[Operator:]

Good morning and welcome to the GCP Applied Technologies Q4 2020 Earnings Conference Call. Please note, that this event is being recorded. I'd now like to turn the conference over to Betsy Cowell, VP, Investor Relations. Please go ahead.

[Betsy Cowell:]

Thank you. Hello, everyone, and thank you for joining us on today's call. With us on the call are Simon Bates, President and Chief Executive Officer; and Craig Merrill, Chief Financial Officer. Our earnings release and corresponding presentation slides for this quarter's results are available on our website. To download copies of the presentation, please go to gcpat.com and click on the Investor tab.

[Simon Bates:]

Thanks, Betsy. Good morning, everyone, and thank you for joining us today on our earnings call. Let me begin with our announcement last week where we informed our investment community that GCP have identified various material weaknesses within our financial controls during the fourth quarter 2020. Craig will talk about the circumstances leading up to the non-material revisions of our prior period financial statements and the plans to remediate our financial control shortly. I want to note that I've been very pleased by the efforts over the last three months by our new team working with our internal auditors and external auditors and we are confident that we have identified the issues and have a clear path to remediate them. We are committed to improving GCP's financial controls, process and procedures. We expect to file our Form 10-K within the 15-day extension period. Additionally, I'd also like to thank our employees around the world for their resilience during 2020 dealing with the global pandemic. Last year and this year, our employees have responded to the COVID-19 environment with dedication to deliver on our commitments and results. So, thank you to them. Today, I would like to update you on our progress during the last 90 days around our goals to stabilize revenues, improve margins and return to profitable growth. In November, I discussed our four priorities. First, to revisit our strategy and more clearly articulate where we will focus our efforts and our plans to drive improvements. Second, bringing the voice of the customer front and center. Third, analysis of our cost structure. And fourth, relying on the data to underpin decision making and accountability.

[Craig Merrill:]

Thank you, Simon, and good morning, everyone. I will begin my remarks with a discussion of last week's announcement with respect to the material weaknesses and resulting revisions to GCP's prior period financial results as reported. 2020 has been a year of change for GCP, with the new Board and new senior leadership team. And as part of these changes, we realigned a number of functions under the purview of the CFO office, which included our new Chief Accounting Officer, James Waddell. And during the fourth quarter, the Information Technology Department, the previously named Business Transformation Group and the Customer Service Department temporarily reported to the CFO. With this change, we initiated a review of accounting policies and controls including certain IT controls and determined a number of them were ineffective. The team also determined during preparation of the year-end close process that certain accrued expenses in prior periods were inaccurate dating back to 2018. This work led to the final determination of a number of material weaknesses within our controls in connection with certain information technology systems, revenue recognition, general accounting in the close process. Based on the identification of these items, we were required to make revisions to our financial statements impacting prior periods of which the cumulative sum dollar value is immaterial. This incremental effort and time required to ensure the accuracy of our financial statements and proper disclosure of Q4 and full year 2020 results, including prior period adjustments, did cause the delay in providing completed audited financial statements.

[Simon Bates:]

Thanks, Craig. Thank you all for your time today. As the new CEO of GCP, I'm thrilled to be here. I believe there are great opportunities for the Company and feel privileged to work alongside our talented employees to drive GCP forward. My goal is to be transparent, objective and to meet and exceed our commitments. We are telling you what we know now. We are striving to do better and as we have more clarity as the pandemic ends, we expect to be able to provide investors with a long-term outlook and vision for the future of GCP. Thank you for joining our call and we look forward to taking any questions.

[Betsy Cowell:]

Operator, we can now begin the question-and-answer session.

[Operator:]

Our first question will come from Mike Harrison with Seaport Global Securities. Please go ahead.

[Mike Harrison:]

Hi, good morning.

[Craig Merrill:]

Hi, Michael. How are you doing?

[Simon Bates:]

Hi, Mike.

[Mike Harrison:]

Doing well, thank you. I wanted to say I appreciate you guys are sharing some of the findings from your customer and employee surveys. I think that kind of self-reflection can be difficult, but I think it's also healthy and it seems like an important step in the right direction. In terms of the outlook, can you provide a little bit of color on maybe how we should think about the earnings progression during 2021? You know there are some seasonal factors to keep in mind. I think we can probably assume that the recovery in construction activity is gradual during the course of the year. And then you also referenced some raw material costs that may be come in toward the end of the year, inflationary costs that come in during the end of the year. And then there is also these discretionary costs that you temporarily cut back on during 2020 that maybe start to flow back in during the year. So maybe just some initial thoughts on how we should think about the cadence of earnings given all those moving pieces in 2021?

[Craig Merrill:]

Yes, Michael, it's Craig. I think you've hit a lot of the points. It's not easy to really determine the second half as well as we like. But let me give you a little flavor on the first half. Of course, Q1 being down a little bit in volume, probably won't have a little -- a lot of pickup in profit in Q1 probably similar to prior year. And then of course Q2 will be a little better because of the situation last year on the volumes because that was the most dynamic Q4 in the pandemic, so that would have a pickup. And then the second half is a little bit tougher to call. I think you've got inflation coming through, which we will work on price. But it's just a question of how much we can pass through and how quickly the inflation comes through, but we do expect that to happen. So there might be some margin degradation in the second half that we have to work on with price just year-over-year. So -- and then on cost, we're going to work to try to hold that savings that we've had from 2020 through 2021. But there are some offsets to that, like the rent in Cambridge, obviously merit and some other inflation. So your overall operating expense generally will probably be about flat full year year-over-year with all that being said. Is that -- does that give you a little bit flavor for the pandemic ?

[Mike Harrison:]

Yes, that's helpful and I definitely understand. As I kind of ticked off all those moving pieces, there is a lot to try to take in there. I guess maybe on the specific to the raw material versus pricing situation, can you talk about your ability to pass pricing along the customers in both the SCC and SBM segments? And maybe is inflation more of a concern in one segments or the other?

[Craig Merrill:]

Well, in this construction industry, as you know, you're always about 60 to 90 days behind on price versus inflation to pass it through. You've got quoted specific projects that are going on, specifically things like fire proofing and some of the big projects. You can't move price through as fast as you like. But that also helps in some years. So you'll note in some of the notes we outlined in 2020, we got some nice deflation and we didn't have to give back a lot of price. In fact, we held our price. But I think in 2021, we'll have to give back a little price on that deflation on the early first half of the year and then we will push for price in the second half. But when inflation comes in the second half, usually you're a little bit late on it. So you'll get it in 2022. I don't know if that helps on that answer, but that's -- I'll let Simon weigh in too because he is from the industry also.

[Simon Bates:]

Yes. Hi, Mike, Simon here. I think it's a mixed bag and it's difficult to provide the kind of specificity you would like. We are definitely seeing some price spikes and it seems to also be driven by the weather and the impact on some of the raw material supplies in February. And quite honestly, we are trying to unpick what is some temporary blips on price versus what we can expect for the rest of the year. And so, there is some analysis that kind of goes on, on a daily basis for us trying to see where those prices for the raw materials will settle and therefore how it's appropriate for us to respond in the market. So it's currently a moving target, but something we look at and attempt to manage every day.

[Mike Harrison:]

And in terms of the pace of recovery in commercial projects in particular, I think you made a comment that I think it was specific to North America, you were seeing the commercial construction, they were uncomfortable moving forward with projects. Is that related to the economic environment? Is that related to COVID and safety issues. Maybe talk a little bit about the commercial -- the pace of commercial activity and what's leading to that discomfort, I guess.

[Craig Merrill:]

Yes. And you know that it's -- we -- the biggest exposure to commercial new construction in any of our geographies would be North America, Mike. We are fortunate in some of the disciplines we have in the organization in using various tools to look at our pipeline. So we've got a good view on our pipeline in North America. The part of our business that is being impacted the most is the building envelope business and obviously when we put the water proofing membrane onto the substructure that happens very close to the start of the project. So some of the very large projects, which could be office buildings, they could be tourist attractions, we have seen a whole series of projects delayed and in some cases canceled in 2020 and we are monitoring that very closely in 2021. What we are attempting to do is switch our focus a little bit onto some of the different types of projects, be the data center, healthcare where we do see growth to offset that. And currently our fire proofing business, which tends to happen about 12 months later up, the installation of the water proofing, that business is still looking quite resilient.

[Simon Bates:]

on that. We've had some -- we've seen some nice numbers come through on fire proofing. So on the projects that were already set up to go, they're continuing to finish. So I don't want to give you a false alarm that there's not nice projects out there that we're continuing to work through. And the fire proofing and the specialty group did very nicely in Q4 for instance. And hopefully, these larger projects are just pushed out a little bit on timing. We haven't seen a lot of cancellations yet. That's kind of the situation.

[Mike Harrison:]

All right. And then the last question I have is on North America, that was down sequentially from Q3 to Q4 and on a year-over-year basis seems to have deteriorated a little bit. Is that just the spike in COVID cases? Do you think -- or you referred to some share losses, did those share losses intensify in the fourth quarter?

[Simon Bates:]

No, not specifically, Michael. You saw that my share loss comments were kind of in the yearly view. Generally we saw in Asia a little bit of share loss to the self-manufacturing of some additives, a little bit in China. And on the SBM side, it was North America during the year. But specific to Q4, if you remember last time we had a call, we said that we were a little apprehensive about the distribution channel taking on much inventory and we expected kind of that to happen. There is no way that we're going to take on a lot of inventory in November and December and have it sit there during the winter, which they might, in some instances, other year. So that's kind of the situation. We didn't hold any promotions. Sometimes we do a little promotional activity in Q4 where the distributors do want to hold some inventory and show themselves up, but that didn't happen this year. So it kind of landed about where we expected. So that's more distribution channel management effect than anything else in Q4.

[Mike Harrison:]

All right. And just really quickly to follow-up there, does that suggest that you guys are may be positioned to see a little bit of distributor restocking as we get into maybe late Q1 and in early Q2?

[Simon Bates:]

Yes, if we can -- if this winter would move past us and not be disrupting a lot of the U.S. and Europe, then yes, we expect to have later in Q1 and moving into Q2 that to pick up.

[Mike Harrison:]

Well, we hit 60 in Chicago yesterday or close to it, so spring is coming I promise.

[Simon Bates:]

Congratulations. It will be probably next day then probably tomorrow or the next day.

[Mike Harrison:]

There you go. All right, thanks very much.

[Simon Bates:]

Thanks, Michael.

[Craig Merrill:]

Thanks, Mike.

[Operator:]

Our next question will come from Laurence Alexander with Jefferies. Please go ahead.

[Dan Rizwan:]

Hi guys. It's Dan Rizwan for Laurence. How is it going today?

[Simon Bates:]

Great, Dan. Very good, thanks.

[Dan Rizwan:]

Would you guys benefit directly from a national infrastructure bill if it comes to past later in the year or is it -- I mean what's your views on that?

[Simon Bates:]

We will benefit directly. It's just a question of timing, Dan. Generally, it will take a while for those projects to get developed, engineered in progress. So, the roads and that type of thing, we benefit less, we have less value of our product on roads and things. If it's a little more infrastructure in bridges, which take a little longer to design and get up to speed, then we would benefit more. But if it's past anything -- past in the second half of this year, the benefit would probably come mostly in 2022, I would think for us.

[Dan Rizwan:]

Okay.

[Simon Bates:]

Dan , but we're smiling -- Craig and I was smiling at each other. It's a hotly debated topic internally. Broadly we'd say yes, but our expectation is around more 2022.

[Dan Rizwan:]

Okay. And then you mentioned focusing on North America, I mean, improving your position -- no, I assume or -- is that's going be organically grown, I would think, or maybe you are looking at M&A? And if that's the case, I mean there's something specific that you're going to do is it just executing better or I mean -- how are you introducing new products. So, just wondering, just some color on how you improve your position in this region?

[Simon Bates:]

Yes, so, I think as I said in my introductory comments, when it comes to SCC North America, I think the folks have done a very good job in the last 12 months or so and I see our market position having stabilized for SCC in North America. So, it's how we best support them to get back into growth mode. On the building product side, SBM side, it's a mixed bag. So our fireproofing business, we've done a good job. On the residential and building envelope business, we have a rather complicated supply chain, which has meant service to our customers over the last few years has not been as good as it should. And consequently, we feel like we've lost some market share in those specific two businesses. So we have a whole series of projects that we're working on to improve that service, which we think will help. But we think we can also bolster the business by filling some product gaps that we have in both our building envelope and our residential business. Now, there is optionality to do that organically or through M&A. And given our cash position, we are definitely going to explore M&A in those categories.

[Dan Rizwan:]

That brings me to ; you guys have a very solid balance sheet and improving cash position particularly just given the moves you made in the drop in CapEx, so I was wondering if M&A is the first use of cash or if returning the cash to shareholders is being considered as well?

[Simon Bates:]

Yes, we consider all options and it's a good debate and dialog between the senior management team and the Board at the best allocation of capital. I think the good news is we are seeing more options to drive efficiency and productivity in the business through some better capital allocation, some capital expenditure projects. We definitely can continue to keep the share buyback as an option. And as I said, we're definitely going to explore M&A too.

[Dan Rizwan:]

And then, final question. Just given the changing dynamics in the different end markets, particularly in the building side, I was wondering if the focus on residential or increased focus on residential via new products or whatever is something that you're concerning to?

[Simon Bates:]

Yes. In terms of our strategy and alignment with the Board, we definitely believe a greater exposure to the residential segment to new -- and North America would be a positive for the organization, medium term and that's both residential new construction and residential repair and remodel.

[Dan Rizwan:]

Understood.

[Operator:]

Our next question will come from Rosemarie Morbelli of G. Research LLC. Please go ahead.

[Rosemarie Morbelli:]

Thank you. Good morning, everyone.

[Craig Merrill:]

Good morning, Rosemarie.

[Simon Bates:]

Hey, Rosemarie.

[Rosemarie Morbelli:]

Just following up on your last comment regarding getting greater exposure on residential repair and for new resi, what is the size of that business currently? And getting a larger exposure, does that mean offering additional product lines which would come via an acquisition or do you have product lines that actually could go into that particular area?

[Craig Merrill:]

Well, Rosemarie, we have, as you know, the premium underlayment and roofing, the Ice & Water Shield brand that we had, the Grace or the GCP Ice & Water Shield, that of course goes on all the residential and a little bit of commercial but not a lot. And then, of course, about one-third of our products in the admixture and cement additives goes into residential too in North America. So we actually have a decent portfolio there that we do get benefit of residential and we expect that to be very strong in 2021, so that's good news. With respect to additional products, there are some new products on the red side that they're working both on the underlayment, the air barrier, those types of products that we can get benefit from both on the res and the commercial side, they're kind of dual products where the technology is. So that will help us. But certainly M&A and acquisition opportunities would support our distribution channel and our partners in our portfolio. So we're also looking at that. So that's a nice opportunity for us whether it's organic or through M&A with respect to our position there.

[Rosemarie Morbelli:]

So, thanks, Craig. But, my understanding regarding the underlayment is that it is mostly for repair that it does not necessarily goes with new residential because the -- you don't have the entire roofing system and your underlayment is kind of expensive and it is not really needed on a new roof, I mean on the new construction. Am I wrong in that?

[Simon Bates:]

Rosemarie, we would describe our product is premium, not expensive.

[Rosemarie Morbelli:]

Sorry about that.

[Simon Bates:]

The best in the industry. No, the majority of our product portfolio when it comes to roofing underlayment does go into the repair and remodel segment. But in some geographies, we do have good exposure to new construction. And I think we are -- we think conceptually about proofing a structure. And so we think about what other products we should have in our product portfolio. And we do have air and vapor barriers, as an example, as an extension of our product line for the roofing underlayment. So, we would like to build out more of a system for the residential markets, both repair and remodel and new construction and then have the opportunity to bundle the product through the distribution channel and provide more value and synergy to them and would love the opportunity to bundle products to the end applicator or contractor as well and get an increased share of wallet that way.

[Rosemarie Morbelli:]

Thank you. That is very helpful. Could you talk also about the -- you gave us the dollar amount that -- from the products that you exited, I am assuming they are lower margin product lines. Could you talk about the impact on the margin side or on the EBITDA whichever one you pick?

[Craig Merrill:]

Yes, on the exit countries -- you're referring to the exit countries, Rosemarie?

[Rosemarie Morbelli:]

Yes, sorry.

[Craig Merrill:]

Yes. So if you look at the SCC margins, they have been generally improving over the last two years, actually over the last three quarters. And some of the impact of that is the exit country strategy. I won't give you exactly the specific impact on the margin from those exit countries, but the mix has helped us a lot, that probably is pretty well at the end. From here on we will not be reporting exit country. But certainly there is pick up on that. But it's pretty well at its end, so you won't get further improvement from that. Does that answer your question?

[Rosemarie Morbelli:]

Yes, it does. Thank you. Could you also give us a little more details in behind the loss share? And I do realize that one customer decided to make their own additives, but are they successfully doing it or do you think there is a chance they will come back and are you making progress offsetting that particular loss business?

[Craig Merrill:]

Yes. So in SCC, and I think Simon made the point that we are starting to see some offset on some of that volume whether that's in Asia or in North America, Latin America, certainly they're doing a very nice job with pickup in volume there. So we are starting to see offset on that in SCC. On SBM, I would say that share -- as you know, we had a tough year in 2019 on SBM and I would say early part of 2020, the teams are really engaged in the last half year of 2020 going into 2021. We've reestablished our kind of commercial savvy I would call it. And I think that's putting us in a much better position in SBM. There's more diligence around the commercial activity with respect to the distributor promotion activity and clarity and exactly what we're trying to accomplish. So I think we're over that hump, but I'll let Simon weigh in.

[Simon Bates:]

Yes, I had spent a lot of time over the last few months with the sales teams in North America on both business segments, both SBM and SCC. And I'm also reflecting on the 1,600 participants we had in our customer survey and the comments fed back. I would say on the SCC side, we have a very strong product portfolio and we have excellent technical support. So I think that puts us in a very nice competitive situation or ability. Where we have work to do is around our service and there is various different aspects for that, which I won't go into detail now, but we are working on improving the service side on SCC. And I think that gets us back on the front foot in SCC and enables us to grow organically when we fixed the service piece and that's number one priority for this year for SCC in North America. On the SBM side, again it's mixed fireproofing, has done very well and been resilient. We feel there is a combination of things that have hurt our position for building envelope and for residential, one is service and again absolute number one priority for SBM, I think what's fantastic is the loyalty to our brands amongst our contracted group and I have been very impressed by the quality of our sales groups on the SBM side in North America. There are some other better ones that I've seen in 30 something years. So that gives me a lot of confidence. We just need to do a better job and support those groups around service and I think we could really strengthen our position and get back into growth if we can have some supplemental products and have a broader stronger product portfolio. So those are real strategic priorities for us, for SBM North America.

[Rosemarie Morbelli:]

Thank you, Simon. And if I could ask one last question, could you give us an update on VERIFI?

[Craig Merrill:]

Yes, Rosemarie. Either Simon and I can do that, but -- so during this COVID-19 period, it's been a little more difficult to do installations in that type of thing with the trucks and the people and that type of thing. Our folks have not been traveling as much just like yourself and other people probably. So we've not installed as many as we anticipated, for instance, a couple years ago that we would in this year. But we had good install base. The customers who are using them continue to use it, get value out of it. We did increase our revenues by about 40% in 2020 based on our installed base that we had plus some incremental installs at the current customer base. So, if customers already have the equipment and they want to add trucks, which I think almost all of them have added trucks in 2020, we've continued to do that and we have signed a few new contracts. But that's a slow process for installs. So we'll continue to install units in 2021 at about the same pace as 2020. So we still see growth in that business, but we'll have to wait for the pandemic to finish to really reassess that to determine whether we want to ramp it up again the way we were or whether we're going to continue to service our current customers and continue to deliver value for them. So that's where we're at this time.

[Rosemarie Morbelli:]

Okay, thank you.

[Craig Merrill:]

Thanks.

[Operator:]

Our next question will come from Chris Shaw with Monness Crespi. Please go ahead.

[Chris Shaw:]

Good morning, everyone. How are you doing?

[Simon Bates:]

Hi, Chris.

[Craig Merrill:]

Hi, Chris. Nice to meet you.

[Chris Shaw:]

Just as -- Rosemarie just asked, how big is VERIFI now, overall sales?

[Craig Merrill:]

Yes. We've never really disclosed that. That's been something we've been debating internally whether we should be more transparent on that number, but we haven't concluded that at this fall. So, Chris, I wish I could answer that, but it wasn't something we were going to disclose today. But we may soon because we think that the community outside this room that we're in here should know that and they should understand it, but I'll let Simon weigh in also.

[Simon Bates:]

Yes, I think we will hold off on disclosing it on this call and we'll think about how best to represent VERIFI. But it is a substantial opportunity for us as a significant growth vehicle. The demand is largely untapped globally for the technology. Our -- the level of interest and inquiry around the business or around the technology is as busy as ever. And actually when you think about the importance of sustainability, here is a tool we can put in the hands of our customer base that can drive improved sustainability and is measurable and therefore we expect the demand around the technology to continue to grow.

[Chris Shaw:]

Got it, thank you. And then across the, I guess, the whole company, was the sales into the residential production industry up in the fourth quarter. I guess, I'm really just going to figure out how weak the demand from commercial construction was in 4Q and maybe half of the trending right now kind of?

[Simon Bates:]

Yes, so our sales on our residential -- on our SBM residential were down. We didn't do promotions. We did talk to our distributors. They were less apt to take the inventory in that they were the prior year. However, we did have decent demand in our admixtures, in our cement additive products of which about a third of those go into new residential construction. And that was actually surprisingly strong. And when I say surprisingly, we actually -- we were ahead of our number that we originally expected in North America even though we were down. So we did capture some of that growth and we expect to continue to do that in 2021.

[Chris Shaw:]

And that -- just I thought about this, your comments about maybe getting more into residential products or in markets or expanding more there, I was at the impression and I don't really cover anything so much residential construction exposure, but I always thought there was a much more maybe competitive or volatile market. Is that the case in your view or is that something that you think you could expand and they are getting sort of other 10% now?

[Simon Bates:]

No, I mean, I wouldn't consider it volatile, Chris, when you look at demand since we came out of the Great Recession. You've had steady increasing demand for residential new construction. And I think the ideal situation is you've got good exposure to the residential new and you've got good exposure to the residential repair and remodel. And the reason I say that is the repair and remodel tends to be counter cyclical. So that when you see that drop in demand for new construction, you will see a bump in demand on the repair and remodel, though the pandemic last year completely changed that dynamic interestingly in 2019 where you saw spikes in both residential new and significant spikes in residential repair and remodel across the country.

[Chris Shaw:]

That's makes sense. And then just looking at this year, Simon, what should we as analyst be looking forward, sort of milepost would you encourage us to sort of look at it. I would think maybe margins and sort of maybe costs -- sort of cost things which should be the things that we should first focus on that, I guess, the first achievements this year that we could be looking towards. Is that right? How would you like us to think about sort of how 2021 rolls out?

[Simon Bates:]

Yes, look, we are focused on stabilizing revenues. We're focused on improving margins. And I think we've got line of sight to some good projects that we are working on in terms of improving our overall cost structure. And, of course, it's always about speed of execution and delivery, but that is a primary focus for us. I think the thing that makes it a little murky quite honestly is we benefited from raw material price deflation last year and we have some cost inflation currently. So I think that confuses the picture for us and is that combination of ability to move volume, improve pricing and manage our cost down to try and improve those margins, that's our focus. I'm not going to provide any more detail than that at this point.

[Chris Shaw:]

All right, it's helpful. Thanks a lot.

[Operator:]

This concludes our question-and-answer session. I'd like to turn the conference back over to Betsy Cowell for any closing remarks.

[Betsy Cowell:]

Thank you all for joining us today, and have a great afternoon.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.