GCP Applied Technologies Inc. (GCP) Q3 2019 Earnings Call Transcript

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GCP Applied Technologies Inc. (NYSE: GCP)
Q3 2019 Earnings Call
Nov 6, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day and welcome to the GCP Applied Technologies Third Quarter 2019 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Joe DeCristofaro. Please go ahead.

Joe DeCristofaroVice President of Investor Relations

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, Head of Global SBM; and Craig Merrill, Interim 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 US 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. All revenue and associated growth rates in this discussion are stated on a comparable constant currency basis, which adjust for the impact of foreign currency.

With that, I’ll turn the call over to Randy.

Randall DearthPresident and Chief Executive Officer

Thanks, Joe, and good morning, everyone. I’d like to begin by reiterating what I said in the press release we issued this morning. I’m pleased with our accomplishments and performance in the quarter, with sales of $271 million and adjusted EBIT of $35 million that met our expectations.

Our fourth quarter is off to a good start with results for October also hitting our targets and we are reaffirming our 2019 guidance. We still have a lot of work to do, but we have taken significant actions that are working. We have made progress installing our new organizational model and have advanced our restructuring programs. We have sustained growth in SCC’s earnings and in VERIFI and we have initiated our performance improvement plan for SBM. And you’ll hear more about this in just a few minutes.

There are a number of items from the third quarter that I would like to highlight. SCC’s recovered continued with very strong year-over-year margin improvement. In fact this is the third quarter in a row that margins have improved by at least 200 basis points on a year-over-year basis. VERIFI’s positive momentum continued with 53% year-over-year growth in our installed truck base and 27% sales growth. We continued to secure marquee wins in SBM in areas where we are strong, such as airports and large commercial building projects.

We are implementing our new SBM strategy that we discussed last quarter and have engaged a leading global consulting firm to help with certain elements of our plan. We’re doing a nice job to capturing price to offset inflation which has moderated. In fact we are on track to have our best year price capture as a public company. We are improving our adjusted free cash flow as a percentage of sales and also as a percentage of adjusted EBIT due to a greater focus on working capital management and forecasting.

And I’m happy to say we are executing on our restructuring programs as planned with about $28 million of savings this year. Looking forward, we are closely monitoring global construction spending data as we close out 2019 and develop our plan for 2020. Growth in the global construction market has become more challenging due to economic uncertainty and the geopolitical tensions we are seeing worldwide.

As a reminder, about 50% of our sales are generated outside of the United States. In the meantime, we remain focused on what we can control, including the implementation of our restructuring programs, sustaining SCC’s margin increase and improving SBM’s performance. I’d now like to turn the call over to Naren for an update on SBM. Following Naren’s comments, Craig will review the Company’s financial performance for the quarter and our guidance. Then I will discuss our SCC business in little more detail and will conclude our prepared remarks with additional comments on our Company’s progress toward improving our performance and creating value for shareholders. So, Naren?

Naren SrinivasanChief Strategy, Marketing and Business Development Officer

Thank you, Randy, and good morning everyone. SBM’s performance in the third quarter was consistent with our expectations for both sales and earnings. Importantly, during the second half of the year we have continued to win high-profile commercial and infrastructure projects worldwide. These include airports, large mixed-use developments, sports arenas and bridge decks in the US, Europe, Middle East and Asia. These wins help position us for 2020 and demonstrate the value we provide to customers.

Both gross profit and segment operating margins improved sequentially in the quarter for SBM due to residential contributing a higher percentage of sales as a result of seasonal strength. Our key challenge in SBM continues to be reduced large project activity, year-over-year basis in North America in particular, which has negatively impacted our sales volumes and mix compared to original expectations for the year. We do, however, believe that large project activity will improve and we have been actively building our 2020 pipeline on [Indecipherable] .

Last quarter we outlined our four-point plan to improve SBM’s performance. Our plan includes evaluating our pricing model, further penetrating adjacent market segments, addressing resource needs in those markets where we have opportunities to build a stronger presence and accelerating the introduction of next-generation projects [Phonetic]. We have been making very good progress on these plan elements. As Randy mentioned, we have initiated work with a leading global consulting firm to evaluate market segmentation, channel economics and product pricing to optimize and grow our offering.

We have added and will continue to add targeted headcount in key geographies where we can both secure additional share as well as where we are underrepresented. We are reinforcing our efforts within our project specification team to strengthen relationships with architects, engineers and other projects specifiers to develop our pipeline within the large project space, better access the mid-range waterproofing segment and diversified geographies.

Technology innovation and new product development are critical to our plan, as well as our core competencies and priorities for GCP. I would like to highlight two new products that strengthen our leading below-grade waterproofing portfolio. We have launched Preprufe 800PA, a non-rubberized asphalt-based solution to strengthen our position in North America. In early 2020, we will be launching Preprufe 800XP, a patent pending pending self-protecting foam composite membrane with Preprufe, non-bituminous adhesive, which eliminates the need for a separate protection board. This will provide easier application and time savings to the contractor. We expect these efforts to result in improved performance for SBM and look forward to providing more insights into our expectation on future calls.

I’d now like to turn the call over to Craig who will discuss our financial performance and guidance.

Craig MerrillInterim Chief Financial Officer

Thank you, Naren, and good morning. Just a reminder, all revenue and associated growth rates in my comments are at a constant currency basis. In the third quarter, GCP’s consolidated revenues declined 9% to $271 million, sales were down 4% excluding exit countries. Adjusted gross margin increased 210 basis points year-over-year to 39.5%, primarily due to improved pricing, a favorable impact of restructuring activities and exiting unprofitable geographic markets within SCC, which more than offset unfavorable product mix.

Adjusted EBIT margin declined 40 basis points to 13% in the third quarter as an increase in SCC’s gross margin was more than offset by reduced operating leverage due to lower sales in SBM. Turning to the performance of our segments, SCC, sales were down 7% to $154 million. Excluding sales of about $13 million from market exits, sales were up 1%. Growth in Latin America, North America and EMEA, excluding market exits, was offset by a decline in Asia-Pacific.

The strategic actions we have undertaken in SCC continue to have a positive impact. SCC’s gross margins were up 490 basis points due mainly to improved pricing, a favorable impact of restructuring activities and the exiting of unprofitable geographic markets. Segment operating income grew 56% compared to last year’s third quarter as we delivered improved gross profit on lower sales and reduced operating expenses as a result of the restructuring actions.

SBM’s revenue was down 11% year-over-year. Our project-based Building Envelope business was down 12% as growth in EMEA was more than offset by declines in North America and Asia-Pacific. Residential and specialty product sales were down 13% and 8%, respectively. Though margins improved versus the second quarter, SBM’s gross margin declined 140 basis points compared to the third quarter of 2018 due to unfavorable product product mix and lower volumes year-over-year, although price increases offset higher raw materials. SBM segment operating income was down 25% primarily due to the lower volume.

Corporate costs were $11 million in the third quarter compared to $7 million last year, primarily due to unwinding long-term incentive compensation in last year’s third quarter that did not repeat in 2019. Adjusted free cash flow exceeded our expectations for the quarter.

Looking at 2019 guidance, we continue to expect sales of $1.02 billion to $1.05 billion in constant currency. In our forecast, we assume that price more than offsets the impact of inflation, which is now moderating; we expect total operating expenses for the year to be down more than $10 million full year primarily driven by savings of $28 million, offset by planned VERIFI investments and employee-related expenses.

Of the $28 million in savings, the largest contribution is the $18 million that’s coming from the market exit program, followed by our supply chain and G&A programs, respectively. Our forecast for adjusted EBIT remains a $100 million to $115 million full year. As a reminder, the savings we are capturing in our P&L for 2019 are more than offset by the decline in sales and negative mix due in particular to lower-than-expected project activity in our higher margin SBM business.

For SCC, we continue to expect 2019 sales to be down 7% to 9% primarily due to the market exits and adjusting for market exits we expect to be approximately flat in sales for SCC. We expect segment operating margin improvement of between 250 to 350 basis points as a result of higher gross margins and restructuring programs.

For VERIFI, we expect truck installs to more than triple in 2019 to over 1,500 compared to about 500 installs in 2018, producing growth of more than 60% in our installed truck base. We expect sales growth to be approximately 30%. We have signed some large contracts in the last two quarters and therefore the revenue flow-through is occurring more in the second half of the year. We expect acceleration in our quarterly revenue growth as we conclude 2019 and move into 2020.

Our expectation expectation for 2 Plan is for $50 million to $75 million in fire [Phonetic] related revenue, which includes data, materials, management and admixture usage, all revenues that we would not normally generate without VERIFI. Turning to SBM, we continue to expect 2019 sales to be down 5% to 10% compared to prior year due to lower project volumes, and segment operating margin to decline 250 to 400 basis points, largely due to unfavorable mix and lower volume. Our guidance for adjusted tax, adjusted EPS and adjusted free cash flow is unchanged.

With that, I’ll turn it over to Randy.

Randall DearthPresident and Chief Executive Officer

Thanks, Craig. So looking at the past three months, we have made significant progress. The organizational restructuring that we launched on September 1st is working as planned. P&L ownership is evident. We are continuing to focus on forecast accuracy through greater accountability and better tools.

In addition, we are identifying areas for more resources in the field to support our revenue targets. Any additional SG&A we take on will be a reallocation of existing resources or targeted strategic hires that are included in our guidance. Our new organizational structure also includes greater focus on the customer experience as solidifying our relationships with customers is a core GCP priority and is receiving renewed emphasis from our commercial leadership team.

We are regularly reviewing key customer relationships at the leadership level and are establishing more senior roles to ensure higher customer satisfaction. We are also optimizing our internal processes in building new capabilities with data analytics and automation that provide increased value for customers.

In addition, this month we are launching our first e-commerce portal, which we call GCP PLUS. We expect this portal to strengthen our connection with customers through enhanced customer service. Our cost out and efficiency efforts are also working as expected. As Craig mentioned, we expect our announced restructuring programs to yield about $28 million in savings, as well as an 8% to 10% reduction in headcount.

We continue to target over $80 million in annualized savings by 2021 and we are looking for additional ways to become more efficient and drive more savings. In fact, the number of savings opportunities we have identified as a global team is greater than expected. And to give you an example, we have just initiated a comprehensive evaluation of our tax structure with a large multinational tax advisory firm. The project is designed to optimize our tax rate over time and provide additional bottom lines

Craig MerrillInterim Chief Financial Officer

We are also investing in improved production and inventory management systems to drive efficiency in our manufacturing operations around the globe. As I mentioned in my opening remarks, we are improving our adjusted free cash flow as a percentage of sales and as a percentage of adjusted EBIT. Our new organization is helping to sustain our focus on cash, along with new tools for accounts receivable and inventory tracking. We will manage our working capital with a strategic balance between growth initiatives and legacy business needs.

Turning to SCC, we have clearly prioritized quality of earnings by emphasizing core markets and executing on our restructuring programs. At the same time we are optimizing our sales efforts to make sure we have the right people in the right places. VERIFI is a key part of our SCC strategy as it relates closely to our core admixtures business. We are committing resources strategically to drive contract signings and truck installations.

VERIFI changes the way we interact with customers. It allows GCP to become an end-to-end solution provider that is capable of delivering operational productivity, materials efficiency and commercial leverage to our customers. My discussions with executives and our customers validates their interest in our technology and confirms that we’re on the right track.

And finally, we view sustainability as a corporate responsibility and an important part of what we do. Sustainability refers to both GCP’s products and services which create more durable and more efficient structures, as well as how we manage our physical footprint. We expect to publish our first sustainability report next year which will outline our philosophy and how we contribute to more sustainable construction practices and structures.

Before I conclude, I would like to comment on three additional topics. First, we are now developing our annual operating plan for 2020. We are leveraging forecast after seeing improvements, deeper insights in the global construction market trends, as well as demand side insights to build a well thought out plan. We will provide details on our expectations for next year on our fourth quarter earnings call.

Second, as I mentioned on our last call, we recognize that our balance sheet is in great shape. Our Board and Management team regularly discuss capital allocation and we continue to believe that is in our best interest to preserve our financial flexibility at this time. We will continue to discuss capital allocation with our Board and we’ll update our approach as appropriate.

Finally, we have initiated a search for a permanent CFO. Our search has no specific timeframe, but we are working to appoint a permanent CFO as soon as

Randall DearthPresident and Chief Executive Officer

soon as possible and we’ll provide an update at the appropriate time.

So I would like to wrap up my comments by thanking our employees personally and on behalf of my leadership team for all of the hard work and effort that they have devoted to the implementation of our plans. So thank you very much for joining our call and we now look forward to taking your questions.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And we will take our first question today, and that is from Mike Harrison with Seaport Global Securities. Please go ahead.

Mike HarrisonSeaport Global Securities — Analyst

Hi, good morning.

Randall DearthPresident and Chief Executive Officer

Good morning, Mike.

Mike HarrisonSeaport Global Securities — Analyst

I wanted to maybe just start — it sounds like you guys are very much internally focused right now and that the restructuring efforts are going pretty well and you’re working to control what you can. I was wondering if you can maybe comment on what you’re seeing in terms of construction activity, going region by region and maybe comment on the trends that you were seeing in Q3 going into Q4, any signs of acceleration or deceleration in each of those regions.

Randall DearthPresident and Chief Executive Officer

No, the last — Mike, the last quarter we talked about the fact that we saw that the global construction market was moderating and I would say we would stick to that and perhaps even on a global basis say declining somewhat. Here in the US, our construction market growth definitely is moderating and in Europe we talked a little bit about that, it still is remaining challenging, some of it due to the Brexit situation. And when we go across the globe to the Asia-Pacific region, we are seeing some softness there. When you add to that some of the geopolitical elements like in Hong Kong and also the trade situation, that’s not helping the situation. So again, globally I think moderating to slightly declining is the way we’re looking at the market.

Mike HarrisonSeaport Global Securities — Analyst

And then, I wanted to ask specifically about the SBM segment. You noted the unfavorable product mix that had impacted margin in that segment, but it sounded like when you talked about the sub-segments, it didn’t really strike me that any of those were significantly better or worse than others. So can you maybe give a little more color on what’s going on with the product mix there, that’s a good start.

Craig MerrillInterim Chief Financial Officer

Yeah, Mike, it’s Craig speaking. A little bit of it is geographic mix, a little bit in North America. It was a little softer in volumes as a percentage of the total SBM volume decline and then there was some categories in the product in North America just on the higher margin product versus some of the mid-margin products.

The high — the large projects tend to have the high-margin products that we sell in them. So that mix kind of impacted us a little bit, not just on the volume, but also the mix and margin, that’s kind of the way it plays out. It may be hard to find in the results, but they are actually there. So the drop-through is a little bit higher on the SBM on the volume than what we would like it to be.

Naren SrinivasanChief Strategy, Marketing and Business Development Officer

Mike, it’s Naren. And just to add on to what Craig said, I mean the topic we discussed in our last quarter in terms of being a fewer number of large projects, that has continued. We did reset our expectations for the rest of the year. And so I would say that what we are seeing is in line with those expectations. But nevertheless, the mix and move away from the larger projects does have that impact on margins.

Mike HarrisonSeaport Global Securities — Analyst

Got it. And then maybe another question for you, Naren, is on the distributor inventory reduction within your residential business. How much did that — do you think that contributed to the 12% decline in volume and is there more to come in terms of destocking or kind of what can you say about distributor inventory levels at this point?

Naren SrinivasanChief Strategy, Marketing and Business Development Officer

For the third quarter as a whole, destocking was still an important variable here and we did see that have an impact. But as we closed out the third quarter and we look ahead, we are seeing the situation stabilize and we are seeing additional pull through in the marketplace, which is good. The year-over-year comp is still negative as we mentioned, but we are seeing some benefits right now.

The entire market within distributors, there is that consolidation that we talked about in the last quarter and that does impact overall inventory levels in the channel. So given the overall outlook that Randy mentioned, which is moderating to declining, even though we’re seeing that pull through right now there is still quite a bit of cautious behavior out there in the marketplace.

And so there is a little bit of goodness with stabilizing improvements, but all of our customers, whether it’s applicators, they are being cautious. So it’s a little bit of both right now, Mike.

Mike HarrisonSeaport Global Securities — Analyst

All right, thanks very much.

Operator

Thank you. [Operator Instructions] We’ll take our next question and that is from Laurence Alexander with Jefferies. Please go ahead.

Laurence AlexanderJefferies — Analyst

Good morning. Just to flush that out a little bit, as you think about the way the backlog of new signings is developing and you think about how this year evolved, going into next year, is the backlog weaker or was the issue this year slippage against the backlog?

Naren SrinivasanChief Strategy, Marketing and Business Development Officer

Sure. It’s Naren here. I would say as we look ahead into 2020, our overall pipeline of projects on a year-over-year basis is stronger today than it was a year ago. So as we looked into 2019 versus looking at 2020 right now, the overall pipeline is indeed stronger, which is good to see. And again, I would just caveat that with the same remark I did in the last question, where we continue to see just a bit of cautious behavior, just given a lot of the macro uncertainty, whether it’s kind of in the US with the economy, Europe with Brexit or Asia with trade, etc. and tightening credit also in Asia. So that’s how I’d answer to that.

Laurence AlexanderJefferies — Analyst

And then for VERIFI, as you’ve been scaling up, how have the economics compared to your initial targets, anything you’d need to tweak in the model or in the way the value propositions frame for the customers?

Craig MerrillInterim Chief Financial Officer

It’s Craig speaking, Laurence. In fact I think in the second half year of 2019, we have been very pleased with the results. We’ve had to tweak a little bit our install process and those type of things, but we’re on track for Q3 and Q4 on our expectations. In fact, our new contracts are at a higher value and price than our previous ones. And so our renewals are also coming through very nicely. In fact we signed some nice orders in the second half year. And in fact we’ve got enough in the pipeline to cover our Q1 install rate that we kind of expect moving into next year. So we’re very pleased and it looks like it’s on track as we expected.

Randall DearthPresident and Chief Executive Officer

Yeah. And as we’ve said before, Laurence, $50 million to $75 million is the 2021 target as we pointed out data management, materials management as well as admixture usage, that again we would not have had without the VERIFI. To put in perspective and this is an interesting statistic, we have delivered so far in terms of load, 7.5 million loads with VERIFI and it equates into 70 million cubic yards of concrete. We’re very pleased with the direction this is going. To Craig’s point, we’re getting better and better what we’re doing, installs, getting them live, manufacturing, all the above. And it’s definitely something that excites us all.

Laurence AlexanderJefferies — Analyst

Okay, great. Thank you.

Operator

[Operator Closing Remarks]

Duration: 29 minutes

Call participants:

Joe DeCristofaroVice President of Investor Relations

Randall DearthPresident and Chief Executive Officer

Naren SrinivasanChief Strategy, Marketing and Business Development Officer

Craig MerrillInterim Chief Financial Officer

Mike HarrisonSeaport Global Securities — Analyst

Laurence AlexanderJefferies — Analyst

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