GCP Applied Technologies Inc.
Q2 2019 Earnings Call Transcript

Published: 7 Aug 2019

[Operator:]

Good day, everyone. Thank you for standing by. Welcome to the GCP Applied Technologies’ Second Quarter 2019 Earnings Conference Call. Today’s conference is being recorded. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] I would now like to turn the conference over to Joe DeCristofaro. Please go ahead.

[Joe DeCristofaro:]

Thank you, Hannah. Hello everyone and thank you for joining us on today’s call. With us on the call are Randy Dearth, President and Chief Executive Officer; Naren Srinivasan, our new SBM leader; and Dean Freeman, Chief Financial Officer.Our earnings release and corresponding presentation slides for this quarter’s 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 our 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.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 Randy.

[Randy Dearth:]

Thanks, Joe, and good morning to everyone. I want to begin by saying how pleased I am to be taking on the role of CEO of GCP Applied Technologies. I’ve determined in the time that I have been here that we have great people and products and a strong customer base, the values are products and services. This is a pivotal time for the company and I look forward to leading our team as we seize the opportunities and address the challenges we are facing to enhance value for all of our shareholders.Now, let me turn to the second quarter and the specific steps we are taking to improve the performance of the company. I will tell you that I’m very disappointed with the company’s overall financial results for the quarter and our 2019 guidance revision. We recognize that there is still a lot of work to do and you will hear from me today is a specific steps I and my management team are taking to address these challenges.Let me start out with the positives. SCC’s recovery continued with improved margins due to our focus on core markets. VERIFI delivered its best quarter for truck installs. We are capturing price to offset inflation, which is now moderating and we are reducing our operating expenses through our restructuring programs.Our major challenge is with our project-driven Building Envelope business. As a reminder, this business specializes in large, complex, commercial and infrastructure projects. In the second quarter, there were less of these projects, particularly in New York and California which had a negative impact on SBM’s volumes. We will talk more about this business in a few minutes.So what are we doing? The following actions are underway to increase our operational efficiency, right size our cost structure and focus the business on profitable growth.First, we have eliminated the COO role and installed new leaders for both global SCC and SBM to establish clear accountability and responsibility through a business unit and a regionally focused organizational model. This model moves management closer to our end markets, shifts resources to our best opportunities for growth and will help us improve our forecast accuracy and overall performance. The model will be rolled out to our employees this week.Second, we have proceeded with additional cost reduction initiatives with the announcement of the new restructuring program with expected annualized savings of $30 million to $35 million in 2021. This program brings our entire cost out initiative to over $80 million of annualized savings in 2021. I will provide more details later in my remarks.Third, we are committed to returning our high margin SBM segment to growth by better addressing adjacent market segments and geographies, reviewing our pricing strategies and accelerating the introduction of new products.And fourth, we are continuing to build out our VERIFI franchise which we believe has significant potential for value creation. This is a unique asset to GCP and to our industry. We are 100% focused on driving these plans and aggressively dealing with the challenges we are facing to prove our performance.I’d now like to turn the call over to Naren. Naren will provide more details on his plans for SBM, which he now leads. He will also discuss VERIFI, a business he played a very significant leadership role in over the past few years. Following Naren’s comments, Dean will review the company’s financial performance for the quarter and our guidance. I will conclude our prepared remarks with additional comments on the actions we are taking. So Naren?

[Naren Srinivasan:]

Thank you, Randy, and good morning everyone. I am pleased to have the opportunity to lead our SBM business and look forward to implementing our plans to improve the segment’s growth and performance.As Randy said, I will discuss SBM and then VERIFI. SBM key strength and differentiating characteristic lies in supplying high performance waterproofing solutions for large, complex commercial and infrastructure projects. It has strong brand names, advanced technology and global specification leadership.Our products have been installed on some of the world’s marquee and most critical structures. In the second quarter, reduced large project activity in important markets such as New York and California, non repeating large projects from last year like the Tappan Zee Bridge and Mexico City Airport and to shift in the market to smaller projects with less demanding waterproofing needs where we are not currently as competitive, negatively impacted results.Looking forward, the pieces are in place for improved performance by SBM and we are initiating the following plan. First, we have begun a detailed evaluation of our pricing model. Our focus for the past several quarters has been capturing price to offset the negative impact of raw material inflation.We have been successful with this effort. However, to achieve this goal, we have limited our promotional activity which along with consolidation in our distribution channel has resulted in continued inventory management and destocking by our customers. We are reevaluating this strategy in conjunction with the other elements of our overall plan.Second, we plan to further penetrate adjacent market segments by leveraging our existing product portfolio. Today, our business is weighted towards large high performance projects and when there are more of these projects in our key markets, we tend to do well. To expand our market reach, we plan to penetrate less demanding projects with new preapproved products that are more fit for purpose, including pre-applied grades for less demanding foundations and non-asphalt grades for post-applied waterproofing projects.Third, as a result of our new organizational structure, we are shifting and adding resources to address additional geographies where we have opportunities to build a stronger presence.And finally we are broadening our portfolio by introducing next generation products in growing segments. For example, our newest weather barrier product is a primer less membrane that accelerates construction time and removes primer from the job site.Within the liquid segment, we continue to invest in our SILCOR and Stirling Lloyd products lines for commercial and infrastructure applications. As always, benefits to the customer of our new products include labor savings, great installed performance and code compliance.Turning to VERIFI, we are seeing momentum in the development of this data-driven business, which we believe can transform the ready mix concrete industry. In the second quarter, VERIFI delivered the highest truck installed performance in its history with year-over-year growth of more than 1,100 trucks or 45%.Sales were up 14% year-over-year. The difference between sale and installed truck based growth was primarily due to weather and timing. In addition to poor weather in the United States, which is our largest VERIFI market, we run trucks for a period of time to calibrate performance for our customers before these trucks generate revenue. With an estimated addressable market of approximately $1 billion, VERIFI is a key source of growth for GCP and remains a top investment priority for the following reasons.First, we are seeing the highest demand for VERIFI units globally from new and existing customers since its introduction.Second, truck installs are meeting our expectations and our leading indicator for sales. We expect sales to accelerate on a quarterly basis as the year progresses resulting in annual growth of over 40% in 2019. We continue to expect $50 million to $75 million of sales in 2021 for VERIFI.Third, VERIFI as a productivity sale, our customers operate in a very competitive environment where productivity and cost reduction are key to maintaining margins. VERIFI provides end-to-end management and visibility into customer operations, resulting in material savings, operational productivity, and commercial leverage.In conclusion, VERIFI is a differentiated asset with a very bright future. And while SBM had a difficult quarter, it has tremendous products, technologies, and selling relationships. We believe that implementing the strategy we reviewed today can lead to profitable growth. With improved and more consistent execution, we expect better long-term results will follow. We’ve looked forward to providing updates on SBM’s progress.I’d now like to turn the call over to Dean who will discuss our financial performance and guidance.

[Dean Freeman:]

Thanks, Naren, and good morning everyone. Just a reminder, as Joe pointed out, all the revenue and associated growth rates in my comments are on a constant currency basis. In the second quarter, GCP’s consolidated revenues declined 10% to $272 million. Sales were down about 5% when you exclude the exit countries.Adjusted gross margin increased 80 basis points year-over-year to 38% principally due to the favorable impact of exiting unprofitable geographic markets within SCC with price more than offset in the raw material inflation that we saw in the quarter.Adjusted EBIT margins declined 160 basis points to 9.6% in the second quarter as lower sales volumes offset and increase in gross margin, and a decline in operating expenses. SCC sales were down 10% to $157 million excluding sales of about $16 million from exit countries. Sales were down about a point. Sales growth in Latin America and EMEA excluding the market exits were offset by declines in Asia Pacific and North America. The decline in North America was principally due to the weather-related project delays that we saw.The strategic actions we’ve undertaken in SCC continued to have a positive impact as you’ve seen in the results. SCC’s gross margins were up 300 basis points with higher prices and the favorable impact of exiting and profitable geographic markets more than offsetting raw material inflation.Segment operating income grew 13% compared to last year second quarter. We overcame the decline in sales volume with the lower operating expenses as a result of restructuring actions. SBM, however, saw revenue was down 10% year-over-year. While residential sales increased about a point. Our project based Building Envelope business was down 14% and the specialty products were down 6%.SBM’s gross margins declined 240 basis points compared to the second quarter of 2018 due to the unfavorable product mix and the low volumes with price increases more than offsetting higher raw material costs.SBM segment operating income was down 30% primarily due to lower sales volumes. We have revised our 2019 guidance primarily due to the lower second quarter volumes and reduced volume expectations for the second half of the year, largely due as a lower expected project activity. We now expect 2019 sales of a $1.20 billion to about a $1.50 billion or down 7% to 9% versus our previous guidance of down approximately 2%. Our forecast for adjusted EBITDA is $100 million to $115 million.In our forecast, we assume that price will more than offset the impact of inflation, which we do see now moderating. With our additional restructuring plan, we now expect $31 million in savings to impact our P&L in 2019, partially offset by normal annual salary increases and the investments in growth programs such as VERIFI.However, for 2019, the magnitude of mix of the reduction in sales volumes more than offsets the net savings we are capturing in the P&L, due in particular to the lower expected project activity and our higher margin SBM businesses.For SCC, we expect 2019 sales to be down 7% to 9% primarily due to market exits. Adjusting for market exits, we expect the business to be around flat and we expect segment operating margins improvement of 250 basis points to 350 basis points as a result of the higher gross margins and the restructuring savings.For SBM, we now expect 2019 sales to be down about 5%to 10% compared to prior year on the lower project volume with the segment operating margin to decline 250 basis points to 400 basis points largely as a result of the unfavorable mix and the lower volume.Moving forward, our adjusted tax rate is now expected to be 29% to 31% compared to our prior forecast of 27% to 29% and this is due largely due to the lower than expected profit before tax and lower tax jurisdictions such as the U.S. and the higher relative impact of permanent items, which obviously don’t move in line with changes in the profit before tax.Adjusted EPS range is expected to be $0.75 to $0.92 and we now expect cash to be a $35 million to $50 million, adjusted free cash compared to last year about $44 million. And that’s largely as a reduction in the forecast for earnings.With that, I’ll turn it over to Randy.

[Randy Dearth:]

Thanks, Dean. So let me comment further on our restructuring efforts. So as we reported on our last call, our SCC market exit program is substantially complete and our supply chain restructuring program is well underway. And last night, we announced a new program which targets an additional $30 million to $35 million in annualized savings. This program is focused on streamlining the company’s sales, general and administrative expenses to create a leaner organization with business support functions and resources more closely aligned with the company’s commercial opportunities.We estimate about $4 million in savings will benefit 2019, $20 million will benefit 2020 and $9 million will benefit 2021.Looking at our restructuring efforts, we have moved with urgency and have made important progress. And as you can see in our financials, our expenses declined year-over-year in second quarter. We expect this trend to continue and I can assure you, we will continue to look for ways to create a more efficient operating model and align our cost structure with the opportunities we have available.I look forward to providing further updates on our progress. This is my first call as CEO. I’d now like to provide insight into our capital allocation philosophy. Our Board and management team regularly discuss capital allocation. And at this time, we have decided to preserve our financial flexibility.Our priorities are improving GCP’s performance and investing to support organic growth and technology development like VERIFI. We will of course continue to discuss with our Board opportunities for capital return for shareholders and we will update our capital allocation philosophy as appropriate.And finally, I’m happy to be adding two seasoned executives to my senior management team. As you know, Naren Srinivasan will lead SBM. Naren has held a number of executive levels, strategic roles in his career and has deep knowledge of our SBM business. He also played a role in restructuring SCC to focus on core markets as well as integrating VERIFI into our global admixtures business.Boudewijn Van Lent will lead SCC. Boudewijn is a very capable business leader with over 30 years of experience in the specialty chemical industry, which included leadership positions at Bilfinger Industrial Services, Rhein Chemie Corporation, LANXESS and Bayer.Our earnings release includes the details on Naren and Boudewijn’s prior experience. Under Naren and Boudewijn who are global P&L owners for their segments. We are creating regional P&L owners for GCP’s key businesses who will focus on driving profitable growth and customer satisfaction. I am very excited to have both of these leaders on my team.So before I conclude my prepared comments, on behalf of our Board of Directors and our management team, I would like to thank Greg Poling for all of his contributions that he has made to our company for over 40 years. We look forward to continuing to benefit from his deep knowledge of the business in his new role as Executive Chairman of GCP. In his transitional executive Chairman role, Greg will focus on assisting me with customer relationship transitions, cost outs and R&D projects where we leverage his specific background and his expertise. In addition Greg will help with evaluation of any strategic opportunities should they emerge.So I would now like to conclude by saying the following

[Operator:]

[Operator Instructions] And we'll go first to Mike Harrison with Seaport Global Securities.

[Mike Harrison:]

Hi, good morning and congratulations on the new role, Randy.

[Randy Dearth:]

Thank you. Good morning.

[Mike Harrison:]

And Naren I should say as well.

[Naren Srinivasan:]

Thank you very much.

[Mike Harrison:]

Randy I was wondering if you can comment a little bit on the strategic review process that was concluded in June, and just maybe talk about particularly with Greg moving into this Executive Chairman role and still evaluating potential opportunities on the strategic front. Is that a process that you view as having concluded and you're looking to move on and continue as an independent company or do you view that process as ongoing and potentially looking for a more transformative type of deal?

[Naren Srinivasan:]

No, as you correctly say, we announced in June the conclusion of the strategic review process and at that point in time we announced that the Board concluded pursuing our company's standalone plan was the best way to go and very much consistent with that when you heard our remarks today we are taking strategic steps to look at our new organization, to look at additional restructuring, obviously improving SBM is a high priority, as well as supporting VERIFI. And I can say the Board is going to continue to evaluate any opportunity that comes along that will drive value for our shareholders.

[Mike Harrison:]

All right. And then wanted to also ask about the Q2 performance specifically if you can break out, if possible, how much of the weakness was related to weather impact and if you're seeing some of the project activity being delayed not just from Q2 into Q3 or Q4, but any projects that are being delayed into 2020?

[Randy Dearth:]

Yes, I'll let Naren talk about our projects, but that clearly is our biggest issue in the second quarter and our biggest projects as pointed out by Naren are these very large, complex commercial projects that we just saw in the second quarter move out. Whether in terms of where we looked in the quarter, I would say about the 30 million – 30% to 40%, I'm sorry, of that is related to our weather and mostly on the SEC side. And as Naren pointed out the VERIFI business saw as well some negativity because of that.

[Naren Srinivasan:]

And like I would say on the SBM side, our strength and our focus has been on supplying materials for high performance projects that has really high demanding characteristics. And that's been our strength. And we've done really nicely there. In the second quarter in particular, we have seen a delay on some of these large projects. And as we look at our pipeline, the delays are expected to continue into the second half and into 2020. So as we look at our overall guidance, the reduction incorporates both what we've witnessed in the second quarter, as well as the additional delays that we expect to see in the second half. We do believe we're well positioned for those projects once those projects return. But at this time we can't comment on whether we would expect to see them early 2020 or exactly when, I expect we would have more details on that during our next call.

[Mike Harrison:]

All right. It sounds like those project delays are maybe more related to macro uncertainty than to weather. Is that fair to say, Naren?

[Naren Srinivasan:]

I would say so, I mean, obviously weather does play a factor. But I would say much of this is just due to macro climate. We are seeing a bit of a moderation in many of the construction growth metrics out there. But I would say it’s very much more tied to macro conditions than it is to weather.

[Mike Harrison:]

All right. And then the last question I had is within the SBM business, it sounds like the residential growth was better than what you saw on those large projects. If I recall correctly last Q2 of 2018 you called out some residential sales that had been pushed into July that did not fall in June. So I was just wondering, are we seeing the performance this year just kind of a more normal and a return to that normal pattern? And that's what helped drive the residential sales to be better?

[Naren Srinivasan:]

It's a very good question. And I would say that this is an area that we're spending some time looking at. As we've talked about in earlier calls, we have seen the impacts of destocking through the channel and as we have been focusing on price as we've talked about, we do understand that there's obviously a relationship between price, promotional strategies and inventory management. We do think that this is going to be a more stable year. But as we look ahead in terms of how we better plan for the residential business, we will be looking at all of those

[Mike Harrison:]

Alright, thanks very much.

[Operator:]

We'll go next to Mike Sison with KeyBanc. [inaudible]

[Mike Sison:]

Hey guys.

[Randy Dearth:]

Hi, Mike.

[Mike Sison:]

So if I think about the low end of your guide, and when I model out volumes to get there, it seems to me that your volumes had to be down quite a bit in SBM. Maybe similar to the 2Q and probably a similar level for SCC. So as that sort of plays out, why do you think that would be the case? Because SBM has been a really good growth business for years and it seems odd that this one would – have had this much of a challenge heading into the second half of the year.

[Dean Freeman:]

Well, I think it's – this is Dean, Mike. I think it's exactly for the reasons that Naren articulated or you think you're right. If we kind of look at the performance of BE in the second quarter, I think, our assumptions at this point is that that persists throughout the balance of the year exactly for sort of the factors that Naren outlined.

[Mike Sison:]

You're not losing share in SBM or…

[Dean Freeman:]

I would say that we believe that we still have a very strong leadership position. And all of our SBM products in particular in building envelope and high performance waterproofing. Clearly our strategic choice has been to focus on the premium end in terms of the high performance products as I mentioned. With those projects having delays, that's where we're seeing the fall off in the revenues in the second quarter. But we believe that once those projects get back on track, the revenues will come back.

[Randy Dearth:]

And let me just add to that, Mike, these are big businesses where we have the relationship with the specifiers, the engineers, the architects, the distributors. We know these folks extremely well. So when there is a bid, we know who won the bid. And we can tell you again that our conclusion that these projects that pushed out indeed the conclusion that that we have.

[Mike Sison:]

Right, okay. And then just one quick follow-up. When I think about your second half a lot of companies kind of see their second half, maybe best case, the same as the first half or maybe even lower just because the uncertainty out there with the economy and stuff. But you're looking for a second half that has to be better right than the first half. So can you maybe give us sort of just some thoughts on, because I know you have cost savings that drive the better second half, you might have maybe lower raw materials, but what else kind of gives you that confidence that first – that second half will be better than the – I'm sorry, second half will be better than the first half.

[Randy Dearth:]

Yes, so I mean at the top line, Mike, it's if you kind of pick the midpoint of our updated guidance, it is about a 3% improvement in overall volumes. From an earnings perspective, we've got the additional restructuring actions kicking in, we've got VERIFI volumes improving. And overall expectation that volumes will be slightly better as I pointed out in the second half than in the first half. But I will tell you that where we've seen the volume declines as Lorraine pointed out, is in that higher end, higher performance, higher margin underlayment business. And so there's a bigger drag on earnings as a result of those incremental volume declines versus our prior guidance.But the earnings improvement that we would expect is driven by the factors I just pointed out. It's the incremental cost production, the actions we've already taken sort of coming through as well as the VERIFI growth on the revenue side.

[Mike Sison:]

Got it. Thank you.

[Randy Dearth:]

Okay.

[Operator:]

We will go next to Rosemarie Morbelli with G.research.

[Rosemarie Morbelli:]

Good morning everyone. I was wondering if you could touch following up on the SBM and the large contracts that you are expecting to come back, are we talking about ongoing projects which have been put on hold or are we talking about new projects coming online and you are bidding for them and therefore you are anticipating to gain those bids?

[Naren Srinivasan:]

Rosemarie it’s Naren here. I would say it's more of the projects which have been determined that are now on hold, as opposed to new projects that need to be confirmed and will begin. .As we move more into the second half, I would say that some of the projects that we are looking at have perhaps more new components to it. But in terms of what has happened in the second quarter, it's more delays on existing projects.

[Rosemarie Morbelli:]

Okay. Thanks. And when you talk about going into adjacent market, it sounds as though you are going for smaller type of projects and therefore the margin will be done. Is that what we should be looking for a decline in margin as you grow the volume in the top line for those new projects?

[Naren Srinivasan:]

So I would say that the margins on these additional products remain strong on an overall perspective to GCP. And these are products that we have launched over the past 12 months, 18 months that can complement our high performance products. Some of them are within our preapproved family, which has very strong brand recognition and very strong market position. We have launched products that are designed and engineered for less demanding projects. And so these are projects where we can be more competitive. And I would say as we think about our overall organization and how we add or shift resources, this will be one area that we'll be looking at. And the demand characteristics for these products do vary geography by geography, as well as region by region. And that will play a part in our overall strategy moving forward.

[Rosemarie Morbelli:]

Okay. And talking about geographies, you are getting out of the non-profitable geographies. Can you touch on the areas where you are planning to actually increase your presence in geography?

[Naren Srinivasan:]

So on the SBM side, I would say many of my comments were directed on improving our penetration first in the U.S. As noted, our strength has been in selected key markets, given where our products are in highest demand. So as we think about some of these adjacent markets, whether it's for less demanding waterproofing projects, or whether we think about adjacent product categories such as air barriers, liquid waterproofing, et cetera, we will be looking at diversifying the overall geographic footprint in the U.S. it's not to say that that approach will not be explored outside of the U.S. but many of my comments were focused on the U.S. market.

[Rosemarie Morbelli:]

All right. Thank you. And if I may ask one last one, any change in the overall demand for general infrastructure projects in the U.S. or is that kind of a back burner?

[Naren Srinivasan:]

Yes, we're right now looking at the market very closely and we're seeing data to lead us to believe that the construction market here is moderating. So, we're going to watch that very closely. We have very close ties, as I said a few minutes ago to those specifiers, especially for the large projects in the airports, and the stadiums, and the bridges and the tunnels. And we'll keep very close to them to see what their demand will be going forward in the coming months.

[Rosemarie Morbelli:]

Thank you.

[Operator:]

[Operator Instructions] We'll go next to George Godfrey with CLK.

[George Godfrey:]

Thank you. Good morning. Thank you for taking my question. Wanted to ask about the new leadership and structure at SCC and SBM. Does this change in how these units will be managed and operated? Does that come out of the strategic review? And then I have a follow-up.

[Randy Dearth:]

No, we've actually been looking at this for the past several months and looking at ways that we can get closer to our markets, get closer to being reactive to the needs of the market. And so this is a result of that. We've de layered the organization considerably and so we are indeed creating more visibility to where the projects are, to the trends. And we hope that as well will help us going forward in terms of our ability to project.Your second part of your question, I'm sorry

[George Godfrey:]

I didn't ask anything yet, but I will ask you again.

[Randy Dearth:]

Okay.

[George Godfrey:]

So this change in structured, the thinking was the C-Suite was too far moved from the customer under the older structure and now this is going to bring more management direct touch to the customer. Is that what's driving this change now? Thanks.

[Randy Dearth:]

Yes, so I'm not going to comment on the past strategy. I'm going to focus now on my organization going forward. And I've been in every organization, I think, known to man and I believe truly giving P&L accountability and responsible into the organization really helps allowing people to be able to set goals, achieve goals, measure goals, and the organization that we're setting forth to our employees actually tomorrow with the leadership of Naren and Boudewijn that indeed will do what I hope it will do. And get closer to our customers, get closer our markets and put more people accountable and responsible for their businesses.

[George Godfrey:]

Understood. Thank you for taking my questions.

[Operator:]

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