GCP Applied Technologies Inc.
Q2 2018 Earnings Call Transcript

Published: 8 Aug 2018

[Operator:]

Good day everyone and welcome to the GCP Applied Technologies Second Quarter 2018 Earnings Conference Call. All participants will be listen-only mode. [Operator Instructions] After today's presentation there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Joe DeCristofaro, Vice President of Investor Relations. Please go ahead.

[Joe DeCristofaro:]

Thank you, Gary. Hello, everyone and thank you for joining us on today's call. With us on the call are Greg Poling, President and Chief Executive Officer; and Dean Freeman, Vice President and Chief Financial Officer. Our earnings release and corresponding presentation slides for the quarter results are available on our website. To download copies, please go to gcpat.com and click on the Investors tab. Some of our comments today will be forward-looking statements under U.S. Federal Securities Laws. Actual results may differ materially from those projected or implied due to a variety of factors. We will discuss certain non-GAAP financial measures, which are described in more detail in this morning's earnings release and on our website. Our comments on forward-looking statements and non-GAAP financial measures apply both to the prepared remarks and to the Q&A. References to EBIT refer to adjusted EBIT and references to margin refer to adjusted gross margin or adjusted EBIT margin as defined in our press release. Greg will start us out today with a business update. Dean's commentary will include highlights of our financial results and outlook. We are discussing these results on a continuing operations basis to account for the sale of Darex Packaging Technologies. Additionally, we deconsolidated Venezuela as of July 3, 2017. All revenue and associated growth rates in this discussion are stated on a comparable constant-currency basis, which adjusts for the impact of foreign currency. With that, I'll turn the call over to Greg.

[Greg Poling:]

Thanks, Joe, and good morning. GCP revenues grew 5% in the second quarter with our SCC business up 10% and SBM flat the prior year. Our earnings were negatively impacted by inflation and increased foreign exchange volatility in certain emerging markets. This impacted our cost and SCC business was disproportionately impacted by these factors. SBM revenues were flat in the quarter due to project delays in our decision to reduce customer discounts this was especially in our residential underlayment business which shifted June revenues into the third quarter. Our bolt-on acquisitions are performing well and contributed about $25 million in second quarter sales with adjusted EBIT margins in the 20% range. We are continuing to pursuit a strong pipeline of bolt-on acquisition opportunities. Our construction markets are healthy in North America, Western Europe and Asia; however, Latin America, Turkey and the Middle East are being impacted by the geopolitical events, foreign exchange volatility and the inflation pressures. We are implementing the three-point plan to improve the profitability of our SCC admixtures business and to accelerate the penetration of high-margin technologies such as VERIFI. First, we are raising prices significantly in low profit, high volatility admixtures markets. We are also rationalizing business in a number of these volatile markets and in low profit countries and with certain customers. This will profit admixtures business consuming a disproportionate share of our resources offers minimal near-term opportunities for our differentiated technologies. Secondly, as a result, we are implementing a restructuring program that targets $25 million in annualized sales with about 70% of the savings benefiting SCC business. The restructuring program consolidates facilities, reduces headcounts and lowers operating expenses. Third, we are focusing on growth in approximately 25 to 30 core admixture countries where we are well-positioned generate strong margins by providing best in class product range and a level of service to customers value. We are also focusing additional resources on our growing VERIFI and integrated in transit management admixture system as well as other differentiated admixture and cement technologies. We estimate the addressable admixture market in our focused countries to be about 2.5 billion, with an additional 750 million to 1 billion in VERIFI opportunity. VERIFI continues to gain market acceptance by providing value for our customers who are placed over 45 million cubic yards of VERIFI factory. We estimate ready mix producers can capture $2 to $3 for every dollar spent once they implement the integrated VERIFI into their systems and makes designs. These savings come from reduced admixture and cement use productivity improvements and the benefits of placing higher quality concrete. VERIFI sales are growing at a rate of 60% over prior year. We are targeting VERIFI revenues of $50 million to $75 million by 2021, with adjusted EBIT margins equivalent to or greater than our SBM margins for this business. We also expect additional revenues as we again penetration with our integrated in transit management admixture system. We began implementation on our three-point plan to improve the admixture business in order to strengthen our competitive position provide sustainable margins and accelerate opportunities for future growth built on our new technologies. As we announced in July, Randy Dearth will be joining us on September 1, as GCP’s President and COO, and we look forward to working with Randy and out team to support the execution of our strategy across the Company. I'd now like to turn the call over to Dean for additional details.

[Dean Freeman:]

Thanks, Greg, and good morning everybody. Just to reminder, all the revenue and associated growth rates in my comments are on a constant currency basis. GCP consolidated revenues grew 4%, year over year to 299 million and were up 6% excluding Venezuela and the divested Halex tack strip business. The second quarter began with strong sales with April and May averaging 11% growth. June however was down 3% due to a combination of project delays and our decision to reduce customer discounts in out residential business. As a result, revenue shifted into the third quarter, we now see July sales growing 13% year-over-year, and we expect solid sales growth to continue in the third quarter, supported by strong construction market in our order pipeline. In the second quarter SCC sales were up 9%, admixture sales increased 7% with North America up 15%. EMEA was up 8%. [indiscernible] [0

[Greg Poling:]

Thank you, Dean. GCP sales grew in the second quarter in our core markets remain healthy. Our SBM business is performing as we anticipated given some project delays in the shift in the residential business in the quarter. We’re taking actions to recapture our SCC margins, which were negatively impacted by the inflation involved for exchange rates, we saw in emerging markets. The actions include implementing additional price increases in these markets, initiating a restructuring and repositioning program targeting $25 million in annual savings and focusing our resources on the core admixtures markets and increasing penetration of VERIFI and our integrated transit management administrative system. This three-point plan is designed to improve our SCC margins, reduce our overall cost structure, redeploy resources to higher margin opportunities and lower the overall volatility of GCP results going forward. We want to thank you for joining our call and now Dean and I would be happy to take your questions.

[Operator:]

[Operator Instructions] Our first question comes from Mike Harrison with Seaport Global Securities. Please go ahead.

[Mike Harrison:]

I was wondering if you can maybe give us a little bit more detail on how we should split up the $25 million of restructuring savings into different buckets? And can you talk at all about as you undertake some of these restructuring actions, talk about the tools or the analytical approach that you use to determine what actions you’re going to take? Is there an EVA or ROIC driven approach to those actions?

[Greg Poling:]

Yes, I mean actually in terms of the split of the money the 25 million as I said about 70% of it were accrued to the SCC business that’s both in selling costs and factory admin as well as G&A that’s allocated to that business. So each one of the lines on the P&L benefit, essentially what we did was we re-segmented all of our admixture business. We went down to the territory country and customer level. We went after those businesses that weren’t generating the kind of returns that we expect in this business and we went through an assessment of how much resources we deploy in each one of those countries and to those customers and we put the plans in place that are already developed, approved by the board and being implemented to eliminate the cost associated with business. The cutoff point frankly was not in an ROI. We were looking at contribution margin which for us is defined as gross profit and then selling expenses, and we’re also taking the G&A associated with that. So it was a very detailed re-segmentation of the admixture business which allowed us to take the 25 million of savings through P&L but also as more importantly for us to take those 25 to 30 countries where we have very nice margins, good positions and put resources against growing that business, so it’s a twofold strategy.

[Dean Freeman:]

Just to add to that comment, notably as I mentioned in my comments about $10 million of revenue was just about as part of our updated guidance with little or no impact on gross profit, so that’s just an indicator, the analysis, the optimal -- the analysis and the program we’re undertaking.

[Mike Harrison:]

And then question on…

[Greg Poling:]

One other point -- I am sorry, one other point I would tell you on that 25 to 30 countries from the admixture standpoint, you can think in terms of us eliminating 45 to 50 countries. But you can see about the complications and simplification we’re doing on the business, it does not impact cement, it does not impact SBM. Those businesses continue but that type of complication and complexity we’re taking out of the business so sorry to interrupt but I just wanted to follow-up with that.

[Mike Harrison:]

And then a question on pricing, can you talk in a little bit more detail about how the contracts work in both the building materials and construction chemicals pieces? Are you able to get any more flexibility in this inflationary environment to be able to move prices as you see materials or logistics costs moving? Or you kind of stuck with the contracted price even if it moves three or six months later?

[Greg Poling:]

We’ve traditionally said it takes us a quarter or two to recapture our price. The fact of the matter is in the second quarter and we’ve come out, we didn’t get quite as much in the first, it took us some time but I think team nailed and we came in with about $4.5 million of price in the second quarter. What happened to us was and especially in these emerging markets is FX shift and the oil pass through accelerated on us. Frankly, that is not a contract issue for us in those countries. We just need to go back in and put those prices in and that’s what we are doing as we roll into the third quarter. Where we have the contractual business in the admixture side, North America, The core European markets some of the matured markets in Asia Pacific, we did a pretty nice job of covering the inflation with price in fact in North America we more than covered it. So it was not an issue in this case of the contractual obligations, it was more of the speed with which the oil price changed and typically we would see foreign exchange go the other way with oil but in these countries, we think -- but in this countries boat very quickly. Now that’s the volatility issue we were talking about we’re leaving.

[Operator:]

[Operator Instructions] The next question comes from Chris Shaw with Monness, Crespi. Please go ahead.

[Chris Shaw:]

I guess the question I had at the end some things were I guess fairly on track through the first couple of months, so then you stopped promotion. What was the reason have done in e the residential conditions that caused you to do that? I know it sounds like it’s just pushing sales out to the third quarter, but like what's happening there that such as sort of I guess somewhat dramatic shift in sales could have? Chris it’s a great question I’m glad to give you some color on it. What we have essentially and historically have done in the residential business is that promotional discounts that essentially reduce the prices and with inflationary pressures, we decided to regain that price and we made a decision in the second quarter to eliminate those promotional discounts in that business. What’s happened then was rather than doing the buys that took place as they had those discounts in the prior year, they didn’t buy in June but they bought in July. We see no shift in our estimate for residential so we picked up that margin, but if shifted as Dean said, the res business was down 21% in the quarter. All of that shift came frankly in the latter part of the quarter and we have seen a pickup through July, now we have seen that come back. So, it was a promotional activity that we use. We decided that that was another way to price increases in that business or the best way to and we eliminated those for the quarter.

[Chris Shaw:]

And if I could follow up I guess something you were just before that sort of quick rise in some of the rise in some of the raw materials in the second quarter. I thought on the first quarter conference call you said you guys are -- it’s not like you are ahead caught up to or at least on top of this sort of raw material inflation with price. what happened in the quarter? I don’t remember there being -- maybe there’s some raw material that I’m not following, but that moved up in the quarter so quickly after seemingly being on top of that after the first quarter.

[Greg Poling:]

You are right, we have put in and anticipate and put in pricing in fact were about on our pricing plan for the operating plan for the full year. Two things happened, oil did move 10% sequentially which is the base of some of our raw materials but the big driver for us was in Turkey, Argentina Middle East, parts of India where we have these emerging markets we had a Brazil, a significant change in the FX rate in those specific countries as Dean when you combined them up they will 25%. Usually, when that happens it's the reverse of oil we got them both. So we were buying raw materials importing into those countries and getting the FX hit. So, it was the specificity on that, ex that move, we would have been -- and when you look at our core markets, we did cover the inflation with price so. We thought on track that moved on foreign exchange in those countries, we didn’t anticipate.

[Chris Shaw:]

And then I guess longer term and the SCC segment what is sort of the targeted operating margins for that business?

[Greg Poling:]

That’s exactly the question. So if we think 25 million any other recruits for that business. We picked up 250 to 300 basis points from where we’re now and then the opportunities to ship that business to our core countries where we have better margins those countries 25 to 30 of them borrowing at nice margins, good product lines and those businesses on VERIFI in addition to our admixture business. If you take that verify business and added to admixtures after depreciation, that part of business gets STM margin. So, we expect to bring those SCC margins over time up as we said couple 100 basis points. Once we get more -- once we get the $25 million, $20 million back. So, we took a hit year in those emerging markets where pricing ourselves to recover that hit and then we’re focusing into 25 to 30 markets where we have a position to improve the margins and taken the cost out.

[Operator:]

The next question comes from Connor Cloetingh with KeyBanc Capital Markets. Please go ahead.

[Connor Cloetingh:]

So I was just wondering I know at the end of 2017 and beginning 2018 you had some large projects that you are involved in anything similar to that gives you confidence in your back half outlook or going into 19 that you see on the horizon?

[Greg Poling:]

We do have some really good project work. In fact, some of that shift to play we got some very nice projects in North America, we’re finished -- we got a major infrastructure programs going on, actually couple of going on in New York City which you read about over time. Those are in progress now and starting to ramp. We got some good project work on Mexico that’s sort of in a transition from pouring slabs to building walls and so when they pouring slabs, we do more come back and do some more water proofing there. We picked up some nice work out in Asia Pacific with some of our new projects around shotcrete. We actually our pipeline on the SBM business is up about 10%. The project work is out there the Middle East got pushed out. We have very good business going on in Qatar. You read about what is going on there those projects are getting finished, but they did get pressed out from us that was some of the project delays we saw in the second quarter where shipments into that projects in the third -- our project pipeline is pretty good. Actually our SBM business despite the fact that we had this disruption in the quarter, SBM business is pretty strong we just had raised ships and margin.

[Connor Cloetingh:]

Okay, great. Thank you. And then just a question on your acquisition strategy is it still good pipeline in the works there or any plans for share buybacks in the future?

[Greg Poling:]

Connor, we really like the pipeline that we’re seeing and we’re working on that, so we haven't changed our strategy around capital deployment overall. We got a good pipeline were continuing to work it, our strategy is to buy those businesses that have the kind of margin profile actively synergizing that fit into this structure. We’re sticking with that and we got a good pipeline and we will continue to pursue it, we will tell you about when they get done.

[Connor Cloetingh:]

Great thank you and then just one last one just curious. Could you remind us how much of your SBM business is tied to residential?

[Greg Poling:]

Yes, that res business is about a little less than a $100 million, it is a good business for us and that business is solid this year, but we’ve got a lot of movement in terms of quarterization, but it’s a great question it’s a little less than a $100 million for the quarter.

[Operator:]

This concludes our question-and-answer session and the conference is also now concluded. Thank you for attending today's presentation. You may now disconnect.