GCP Applied Technologies Inc.
Q4 2017 Earnings Call Transcript

Published: 27 Feb 2018

[Operator:]

Good day and welcome to the GCP Applied Technologies Fourth Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Joe DeCristofaro, VP of IR. Please go ahead.

[Joe DeCristofaro:]

Thank you, Nicole. 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 our fourth 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 fourth quarter 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 will turn the call over to Greg.

[Gregory Poling:]

Great. Thanks, Joe, and good morning, everyone. GCP had a strong fourth quarter. Our sales increased 11% and were up 7%, excluding acquisition. Sales were favorably impacted for the first time in quite a while by foreign exchange, which did add about 2 points to our growth. Adjusted EBIT grew 16% due to higher sales and the positive impact of our restructuring programs. Both our SCC and SBM businesses grew in the quarter and momentum has continued into the early part of 2018. Our customer activity and our project pipelines are both healthy. We completed two bolt-on acquisitions during the fourth quarter. Ductilcrete provides specialty concrete flooring. It expands our product line into Engineered Systems. The company has patented technologies that combine specialty admixtures and reinforcing fibers with design support. The products are sold through a licensed contractor network to deliver high-performance, low-cost floors. The company has accretive margins to GCP and we do see attractive growth opportunities in this market segment. We also acquired Contek, a provider of quality control software that manages and optimize mix design for ready-mix producers. We’ll integrate Contek with our VERIFI systems to expand the value we offer to customers through time and material savings, as well as the improvement in the quality of concrete. VERIFI continues to gain market acceptance. We recently assigned three new contracts, which along with our existing customer commitments will provide growth throughout 2018. New and existing customers are realizing value from VERIFI. New customers are adopting to technology, while our existing customers are expanding VERIFI into their fleets. We introduced two new cement products in the quarter

[Dean Freeman:]

Thanks, Greg, and good morning, everybody. Just a reminder, we are discussing results on a continuing operations basis to account for the sale of Darex. Additionally, we deconsolidated Venezuela as of July 3, 2017, and also our revenue and the associated growth rates in my comments are on a constant currency basis, as Joe mentioned earlier. Our GCP’s consolidated revenues were up 9% year-over-year to $286 million in the quarter. Revenues increased 5%, excluding acquisitions and FX added an additional 2 points of growth. SCC sales were up 5% on improved sales admixture customers from pent-up demand following weather events in the third quarter. Cement additives also performed well benefiting from healthy worldwide construction markets and new customer cement additives planned conversions. VERIFI installs grew almost 40% year-over-year. SBM’s revenue increased 16% year-over-year to 7%, excluding acquisitions. Building Envelope sales were up 25% and grew 7%, excluding acquisitions, as global project activity continues to improve. Specialty Products, which includes our fire protection injections, grouts and Halex product lines increased 12%. Looking at the regions, North America revenues were up 10%. Sales, excluding acquisitions increased about 8%. Our admixture business was up 20%, but VERIFI also growing at an impressive rate. Growth in our fire protection business in North America was offset by modest declines in Building Envelope in residential, as well the divestment of Halex as low-margin commodity business. EMEA was up 10% organically and 25%, including the Stirling Lloyd acquisition. Concrete admixtures increased 9% and cement additives were up 7%. Our fire protection ad specialty waterproofing injections business performed very well growing at double-digit rates in the region. In Asia Pacific, revenues declined 1%, as 26% growth in the Building Envelope was offset by a decline in admixtures. Latin America declined 7% in the quarter, primarily due to deconsolidation of Venezuela. However, looking at our two largest markets in the region, Mexico grew at a double-digit rate, while Brazil was flat compared to the same period last year after an extended period of the claims. Moving to our earnings and margin performance, we continue to experience raw material inflation due to increased costs across the petrochemical chain, which is impacted by environmental regulation in China that reduced capacity and third quarter weather events in North America. We’re also seeing increased logistics cost due to higher fuel prices and capacity constraints. We have initiated price increases to cover these incremental costs. However, we expect our normal lag on the impact of pricing due to contractual obligations in project timing. Adjusted gross profit increased 5%, as higher price and the positive impact of our acquisitions was partially offset by unfavorable product mix and the negative impact of raw materials and logistics inflation. Adjusted EBIT increased 16% in the quarter on higher sales volume, restructuring program savings, which more than offset the negative impact of material inflation. SCC’s gross margins declined 190 basis points to 35.2%, as the negative impact of material inflation was partially offset by higher price. Segment operating income was flat compared to the same period last year. And SBM’s gross margins declined 200 basis points to 42.3% due to the negative impact again of material inflation. SBM segment operating income increased 15% in the quarter due to higher sales volume and the impact of acquisitions. Rounding up the consolidated results for GCPin the quarter. Interest expense totaled $14.1 million. Our income tax expense for the quarter included $82 million related to our provisional estimate of the impact of the Tax Cuts and Jobs Act. Our net loss from continuing operations in the quarter was primarily due to the income tax expense. We estimate the tax impact to this expense will be less than $70 million. The cash tax impact to this expense to be less than $70 million paid out over eight years. Adjusted EPS, which excludes the tax expense related to the new law was up 33% to $0.24 a share and our diluted share count was 71.7 million shares. Our adjusted free cash flow came in lower than expected due to strong revenue growth late in the fourth quarter, which increased our working capital usage. Our sales in November and December in particular were much stronger than seasonally normal, which caused accounts receivables to build. We will have collected most of these receivables in the first quarter. Looking at our 2018 guidance, last quarter, we gave you an early indication of our expectations. Those expectations were for sales growth of 5% to 10% and adjusted EBIT growth of approximately 10%. We’ve now finalized our 2018 operating plan. We are confirming sales guidance of 5% to 10% and providing an adjusted EBIT guidance range of $135 million to $150 million. The top-end of our guidance would reflect healthier than expected project activity in a moderation of expected inflation trends with a low-end of the range taking into account higher than expected inflation and a slowdown in construction activity that could result from a weaker economy or rising interest rates. Our guidance range includes increases in salary and benefits, incentive compensation, growth investments, and again inflation in raw materials and logistics expenses. While we’re still assessing the impact of the new tax law, it is a positive development for GCP. We are forecasting a lower effective tax rate for 2018 as a result of the new law between 28% and 31%. We also have potential for increased flexibility with our cash globally. We are forecasting an adjusted EPS range of $0.84 to $1.03. The range includes the annual impact of interest expense savings from paying down about $400 million in term loan and revolver debt in 2017, as well as the lower projected tax rate due to the U.S. tax reform. Our capital investments could be slightly higher in 2018 than our target 5% of sales, due to investments required for a new VERIFI contracts and three new admixture plans to replace sites sold with the Darex transaction. We’re projecting $35 million to $45 million in adjusted free cash flow with improvement in the first quarter comparatively to last year due to receivable collections in the first quarter. Overall, our sales and earnings should resemble a more seasonal pattern in 2018. We expect strong comparative results versus the first quarter of 2017 and forecast for the quarter will produce around 20% of 2018 sales and 10% to 12% of 2018 adjusted EBIT. The second quarter is expected to be the strongest followed by the third quarter and the fourth quarter seasonally weaker those stronger than the first quarter. And with that, I’ll turn it over to Greg for closing comments.

[Gregory Poling:]

Thank you, Dean. To wrap up, in 2017, we repositioned GCP Applied Technologies as a strong focus construction products technologies company. Our performance in the fourth quarter provides momentum going into 2018, and we have a healthy global construction market. We’re launching new products and focused on value pricing and increasing productivity to offset inflation. We will continue to pursue bolt-on acquisitions that add unique capabilities and improve our market positions. We have a strong balance sheet, which provides flexibility to improve our earnings and cash flow. The GCP team remains committed to creating shareholder value. We want to thank you for joining our call. And now Dean and I would be happy to take your questions.

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Mike Harrison of Seaport Global Securities. Please go ahead.

[Mike Harrison:]

Hi, good morning.

[Gregory Poling:]

Good morning, Mike.

[Mike Harrison:]

Greg, you had mentioned that there was some weakness in the concrete admixtures market in Asia Pacific. Can you give some additional color on what you’re seeing there and whether you expect that to return to growth in 2018?

[Gregory Poling:]

Yes. I think, last year we said there was some loss of some customers in Asia and we had some softer markets. We actually think the Asia market for 2018 looks relatively healthy. The Australian market is good. China should be a bit better. We’re seeing some recovery in Singapore. And in fact, we like the way we started in Asia coming into 2018.

[Mike Harrison:]

All right. And on the SBM side you mentioned that the new project pipeline looks better than it did a year ago. Have we just seen some delays there and the pipeline continues to grow and therefore, things are looking stronger, or do you think that this is strengthening in the overall underlying market? I would find that surprising given your comments on maybe a little bit of concern about interest rates weighing on construction demand?

[Gregory Poling:]

Yes. I mean, first, to the interest rate comment, we have not seen that impact demand. It’s just that in terms of our forecasting or our projects to this point. I would tell you that our project pipeline both is a little more even. If you remember last year, it was back-end loaded and then we got the poor weather in the third quarter and pushed some of those programs out. So we’re benefiting in some of those projects that we’ve been talking about now up and running and coming to fruition some good infrastructure projects. I would also tell you that the overall pipeline across sort of the spectrum is a little healthier than it was a year ago, both in infrastructure and new products. And I also think that we’ve got some benefit from the acquisitions as we’ve added those companies that are added into our pipeline. So that’s where those comments come from.

[Mike Harrison:]

All right. And then last one for me for now is for Dean. It seems like there are a lot of moving pieces in the adjusted free cash flow as we bridge from the roughly $9 million you did in 2017 to the $35 million to $45 million guidance for 2018. Obviously, $8 million to $18 million of that is coming from the higher EBIT guidance. I don’t know if there’s some cash tax savings in there from tax reform. But can you help us kind of walk through where the rest of that free cash flow improvement is going to be coming from?

[Gregory Poling:]

Yes. I mean, I think one of the comments that I made earlier is, we are going to a more – a more normal seasonality of our working capital. So as the first-half year is a bit stronger versus 2017, we – we’ve got a more efficient and optimized working capital cycle, so that’s one improvement you’ll see. The other one is, we paid down a fair amount of debt in 2017. We’ll pick up those savings and then to your point cash tax savings, as well as the expansion of EBIT, all contribute to the performance that we expect. And then lastly, I’ll just say, obviously, the acquisitions will contribute to cash year-over-year as well.

[Mike Harrison:]

All right. Thanks very much.

[Gregory Poling:]

Yes.

[Operator:]

Our next question comes from the Laurence Alexander with Jefferies. Please go ahead.

[Laurence Alexander:]

Hi, there. Could you help us think through how to think about the corporate line in 2018 compared to 2017? And sort of you – and just on and then also for the Engineered Systems, how you think the margin profile for those would differ from your – from the balance of your portfolio? And then I guess, the last one would be in terms of raw materials versus pricing. When you think on SBM could get margins back up, can we recoup the full 300 basis points of loss from gross margin?

[Gregory Poling:]

Yes. Let me – Laurence, this is Greg. Good question. So let me take the first two and then I’ll let Dean chime in, if I miss something and talk a little bit about the corporate cost. On your first question or your last question on the price, I guess, your middle one, price and margins, look, the raw material costs are starting to flow-through. We’ve been out with price increases. We would – typically, as we’ve said, it’s a quarter or two to recapture the margins. We started that pricing program in the fourth quarter. So as we roll into the second quarter, we’ll start to see some improvement in the margins, and some of that specifically is in SBM, which is what you asked about. I mean, we started to recover those SBM margins second and third quarter relative to the inflation. There is a lot of mix in the early part of the year, as well as the last part with SBM. So some of the margin that 280 basis points, I think, about 200 of it was inflation.

[Laurence Alexander:]

Yes.

[Gregory Poling:]

Maybe it was 260, the rest of it is a mix profile. So we’ll also recover that in the middle part of the year as the mix gets to our normal calendarization. So on margin and price, we’re out getting the price, inflation continues, Bituthene is up, the rubbers are up, films are up, oil continues to be higher it was last year, but the market is pretty good and we’re working the price hard.

[Dean Freeman:]

Yes, and look, Laurence, to your question on the corporate line, our total G&A just to give a little perspective, improved about 200 basis points year-over-year as a percentage of revenue. And that includes the impact of the acquisitions and about $7 million of restructuring savings that we achieved, excuse me, about $6 million to $7 million of restructuring savings we achieved in 2017. We anticipate another $4 million to $5 million of net restructuring savings benefit in 2018. And overall, I would say, I don’t want to give much more color than this. Our total G&A as a percentage of revenue is – should be about flat maybe up a little bit as we rebaseline incentives and we make certain investments in our G&A growth programs.

[Operator:]

[Operator Instructions] Our next question comes from Chris Shaw of Monness Crespi. Please go ahead.

[Chris Shaw:]

Hey, good morning, everyone, how are you doing?

[Gregory Poling:]

Good, Chris.

[Dean Freeman:]

Good, Chris.

[Chris Shaw:]

I guess a general question to start. In summary you cited, I guess, the guidance. But I mean, the overall market conditions right now in North America, maybe outside of Latin America, I mean, there – is this sort of the best of times for the industry? I mean, I know some of the commercial construction industries are fairly positive backlog maybe hitting a record. I mean, does it get better than this, I mean, again, outside of Latin America?

[Gregory Poling:]

Well, I mean if you look at historical, we’re not at peak construction levels as we were, but I mean, this is a nice even growth rate. I mean, this is good consistent growth. We see – if I sort of went around the world, we think there’s some upside in Brazil. We think the North American market continues. And as we look at infrastructure, that should extend out the cycle as we see it. The European market we keep seeing recovery and I’m pleased with the infrastructure we’re seeing in the Middle East. We’re a little concerned the Middle East might be off because of the volatility on oil, but the infrastructure is good there. And as we said, Asia is – Asia feels a little – especially the Asian countries a little better to us. So I wouldn’t call this a peak structure or – but I do think it’s nice growth consistent around the world and so we’re pleased with the market.

[Chris Shaw:]

Okay, that’s helpful. Thank you. And then in terms of your guidance for 2018 on the revenue line, the 5% to 10% constant currency. What – is there any, I guess, sort of two questions. Is there any projection for future M&A in that number or/and is how much of that number has the benefits from the deals you did in 2017?

[Gregory Poling:]

Yes, and I’ll let Dean also sort of chime in on the FX how we did that. But you don’t have any future deals in that number, but we have rolled in any of the lap on the existing deal. So the range includes the existing acquisitions we’ve made, but we don’t project anything for the future until we get it done. And then Dean on the FX comment?

[Dean Freeman:]

Yes. I mean, we essentially forecasted a 12-month weighted average foreign exchange outlook for 2018. We kind of think about how 2017 played out. The dollar was weaker sort of in the first-half and strengthened in the second-half. As we look at the early part of what we’re seeing in 2018, we’ve got a little bit of tailwind. But it’s tough to know exactly how they will all play out. But essentially we’ve used the 12-month weighted average FX rates for the key foreign exchange currencies that that we operated.

[Chris Shaw:]

Sure. Just quickly you mentioned before the debt pay down over the last year, you got anymore plans for paying down debt or that you kind of come forward again?

[Gregory Poling:]

I think we’re always looking at opportunities and evaluating assessing cost of our debt. And as and when the opportunities present themselves, we’ll take necessary action, I think like we’ve historically proven. But any other plans outside of that, I wouldn’t want to comment.

[Chris Shaw:]

Great. Thank you.

[Operator:]

Our next question comes from Connor Cloetingh of KeyBanc Capital Markets. Please go ahead.

[Connor Cloetingh:]

Hi, good morning.

[Gregory Poling:]

Good morning, Connor.

[Dean Freeman:]

Good morning.

[Connor Cloetingh:]

So I was just wondering, if you could maybe put a percent on how much do you think new products will help for the volume growth in 2018? You mentioned the new cement product and then more coming out over the course of the year. And how much do you think those will help margins improve versus price increases?

[Gregory Poling:]

Yes. So let me – it’s a great question. We like new products from two perspectives. One is the fundamental growth you get from the new products, but it also allows you to go in with your customers and provide a suite that provide some more value. So we get two benefit as we take new technologies to our customers. I would say it’s a couple of points, the high-end three depending on the acceptance rate and I’m not really counting VERIFI in there as a new product, I don’t think. So cut two to three points on the new product side, but you’re a lot – these build over time in the marketplace. And then in terms of each one of those products that we build through the R&D, we try to have a ground rule that those be accretive to our margins as we come out and launch. So places where we’re investing in new technology, we wanted to be a net positive to GCP, maybe not just the specific product line, but the GCP overall. So those margins should be at a higher rate. How much growth we’re going to get out of price versus new products? That’s always a tradeoff. We do a lot of work on reformulations to try to improve our productivity. So we don’t count that in the new product. Those are our reformulations and we’ll get some of that favorability on productivity there. But we have to work all three of those productivity, price, and the new products to offset the inflation.

[Connor Cloetingh:]

Okay, great. Thank you. And then just one more on price. Have you been noticing any pushback from customers, or they’ve been pretty accepting on the pricing – price increases given the raw material environment?

[Gregory Poling:]

We have sophisticated customers and many of them are very good purchasers and they always push back.

[Connor Cloetingh:]

All right, great. Thank you.

[Gregory Poling:]

Yes.

[Operator:]

Our next question comes from Laurence Alexander of Jefferies. Please go ahead.

[Laurence Alexander:]

Hi, there. If you don’t mind too longer-term questions, can you flush out a little bit your current thinking for VERIFI in terms of capital spending that is how much you think you need to spend over the next several years, the sales and then the margins, how we should think about the payback on that investment? And then on Engineered Systems, how much higher margin is that compared to the rest of the portfolio?

[Gregory Poling:]

Yes. So the first one on the Engineered Systems, it would be in the range of the higher-end of the range of an SBM type of product. Now that’s in the concrete business, but it’s more an SBM kind of margin than it is a traditional concrete kind of margin, as I frame it that way. That’s why we like that system so in concrete. Look, we think VERIFI is accretive. It’s accretive to our earnings. We do have to invest cash with it. We have not publicly talked about that number. But we did say with a couple of plants that we have to build coming out of Darex and the investment in VERIFI, our CapEx might be at the 5.5% range on the total revenue versus the 5% this year depending on how the revenues come in and exactly the timing on that investment. But we do try to project that VERIFI capital within that 5% range is going to be a little higher this year. And then the margins on VERIFI are accretive to the concrete business. They’re very good gross profit margins, but we do have the depreciation that flows through that. So it’s not a traditional calculation on that standpoint. We really look into couple of points of EBIT growth relative to the company out of VERIFI, if you want to frame it that way, and we would expect to look at a double – doubling of that business in 2018. I know I’m not giving a specific numbers, Laurence, but that gives you a framework to work from.

[Laurence Alexander:]

But let’s be clear, I mean, what you’re getting out is that, it is EPS accretive already and the EPS accretion should grow from here?

[Gregory Poling:]

It was probably about break-even on an EBIT basis. We’ve probably got a little bit on after depreciation last year, but it should – it will be positive going forward, yes.

[Laurence Alexander:]

Okay, very good. Thank you.

[Gregory Poling:]

You’re welcome.

[Operator:]

Our next question comes from Mike Harrison of Seaport Global Securities. Please go ahead.

[Mike Harrison:]

Hi. I had another question on VERIFI as well. I think you said that the installed base increased by 40% in 2017. You’re expecting that business to double in terms of revenue in 2018, or installed base? Could you just maybe give a little bit more color on kind of what your expectations are?

[Gregory Poling:]

Yes, I think just plus or minus on the doubling other revenue is our target. Some of it will be timing based in terms of the installs as we scale up. But we’re at a bigger install rate than we were last year and then we get the benefit of everything that sort of laps. So you got it right.

[Mike Harrison:]

Okay. And then you mentioned needing to build some new admixture plants, I believe that there have been some other capacity additions in the admixture space. Can you just talk in kind of general terms what you’re seeing in terms of supply and demand dynamics or competitive dynamics and your ability to get pricing in the concrete admixture space specifically?

[Gregory Poling:]

Yes, that’s a great question. We have to replace three plants that we had with Darex, because we moved on the site. That capitals in our numbers will spend some of it this year and will flow into 2017, it’s actually, I mean, 2019, shouldn’t flow back. But that is, we’ll get some productivity on those plants, but it’s actually not new capacity. It’s replacing the capacity that we had. But frankly, on the admixture business, you have to be close to your customers. It’s not a capacity-driven business relative to the value. So you’ve got to have the right products pricing, service and distribution. The capacity utilization in that business really is not going to be the driver of price, it’s going to be the other value that you bring to your customers in terms of the types of products, the service and you have to be close to your customers in order to make the deliveries be effective. So these plants are about providing good service in the markets in which we’re in.

[Mike Harrison:]

All right. And then I know you mentioned that the M&A pipeline is pretty robust right now. You expected some new – some near-term activity there. Can you just comment on whether you’re seeing any larger targets out there? Are we generated – generally still looking at kind of bolt-on type of acquisitions like you’ve done over the last year or two?

[Gregory Poling:]

Yes. I mean, I would tell you that we like this bolt-on acquisition strategy. We like the pipeline we’re seeing. We’re adding some unique capabilities to company. That’s our primary objective in terms of reinvesting the cash as we’ve said. It doesn’t mean, if something was compelling that we looked at that fit the company, we wouldn’t take a look. But we’re really pursuing this bolt-on acquisition strategy.

[Mike Harrison:]

All right. Thanks very much.

[Gregory Poling:]

You’re welcome.

[Operator:]

This concludes our question-and-answer session and concludes the conference call. Thank you for attending today’s presentation. You may now disconnect.