OMNOVA Solutions (OMN) Q1 2018 Earnings Conference Call Transcript

OMNOVA Solutions (OMN)
Q1 2018 Earnings Conference Call
March 28, 2018 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for your patience in standing by. And welcome to the Omnova Solutions First Quarter of 2018 Earnings Discussion. [Operator instructions] Just a brief reminder, today's conference is being recorded, and I would now like to turn the conference over to Chief Executive Officer Anne Noonan.

Anne P. Noonan -- President and Chief Executive Officer

Good morning, everyone it's a great pleasure to speak with you today. In a moment I will provide an overview of recent operational developments, progress on our strategic priorities, and our outlook for the business. First I will turn it over to Paul to make comments on forward-looking statements, non-GAAP measures, and to summarize our financial performance in the quarter.

Paul DeSantis -- Senior Vice President and Chief Financial Officer; Treasurer

Thanks, Anne. Good morning, everyone. Through this [ph] conference call, Omnova representatives may make forward-looking statements as encouraged by the Private Securities Litigation Reform Act of 1995. All statements in this conference call and in subsequent discussions with the company's management other than historical information are forward-looking statements; these statements represent management's current judgment and expectations for future results and other matters.

A variety of risk factors highlighted in the company's form 10-K and in our most recent earnings release could cause business conditions and the company's actual results to differ materially from those expected by the company or expressed in the company's forward-looking statements. In addition, certain financial measures referred to during this call are non-GAAP financial measures. For an explanation and reconciliation of these non-GAAP measures, see our most recent earnings release and investor presentations published periodically on the company's website. Moving on to the results, here's a quick snapshot of some first-quarter highlights.

Specialty sales growth looks particularly good for the first quarter with volume increasing 16% year over year; we saw exceptional growth in oil and gas as well as solid growth across a number of our other specialties. Oil and gas had a particularly strong first quarter. Last year oil and gas was 4.9% of sales for the first quarter and 7% of sales for the full year. In this year's first quarter oil and gas made up 9.2% of sales.

While we expect continued improvement in oil and gas throughout the year, we don't expect this pace of increase to continue, as oil and gas will be facing stronger comparisons throughout the rest of the year. For fiscal 2018 we are using a normalized blended book tax rate of 25% to reflect the lower U.S. statutory rate, which accounts for about a penny of additional EPS in this year's first quarter compared to last year. We expect to continue to utilize our NOLs to offset taxable income.

Accordingly, we don't expect to see any U. S. cash taxes for the next few years. Once we exhaust our NOLs, we'd expect a cash benefit from the new lower U.S.

income tax rate. Net leverage improved to 3.3 times adjusted EBITDA from 3.6 times in last year's first quarter, driven primarily by increased adjusted earnings. Working capital days were 1.8 days favorable year over year, as receivables increased based on the strong sales as well as higher inventory levels required to meet increased demand. We continue to expect improvement in working capital days and it's one of our 2018 incentive metrics.

In terms of use of cash, as we mentioned last quarter at the beginning of December 2017, we prepaid $40 million of our outstanding term loan B. Additionally in early March we repriced that term loan B to take advantage of our improving financial position and lower market spreads. As a result, our variable rate has dropped from LIBOR +425 to LIBOR +325. If rates were to remain constant all year, which is not our expectation, we would save approximately $3 million of interest expense and cash.

Thank you. I'll now turn the call back over to Anne.

Anne P. Noonan -- President and Chief Executive Officer

Thanks, Paul, Good morning everyone. I'm going to walk through the highlights of our 2018 first quarter in the context of our four overarching strategic priorities. As a reminder our priorities are specialties growth, expanded margins and increased cash generation in mature businesses, portfolio optimization to accelerate our specialization strategy while also strengthening the portfolio, and, finally, progress on our One Omnova initiative designed to make Omnova a more agile, efficient, and lower-cost organization. Let me go into detail in respect to these priorities.

Our specialty solutions segment had a solid first quarter, with sales growth of 16.5%, primarily driven by improved volumes. It was the fifth consecutive quarter of volume growth in specialties. Several key specialty markets had significant growth, including oil and gas, laminates and films, elastomeric modifiers, adhesives and sealants, and home and personal care. As Paul mentioned, the growth in oil and gas was exceptionally high, driven by underlying market recovery, the strategic actions we took to strengthen the business during the downturn, and a weak first quarter of 2017.

However, this quarter's specialty-solutions performance was not limited to oil and gas. We demonstrated solid growth across most of our specialty lines. Laminates and films' growth was driven by strong demand in kitchen and bath and RV. We also saw growth in our adhesives and sealants, and home and personal-care markets.

The adhesives-and-sealants growth came from several new customers and strong sales from a new sealant product we introduced last year based on our proprietary technology. The home and personal care markets, which is an example of a smaller specialty market that Omnova serves, also saw growth as a result of our key account-management focus, where we've developed a growing position at a new strategic customer. For specialty solutions, the growth in volume and mix between lines of businesses led to extremely strong profit growth with adjusted segment operating profit growing almost 52% year over year. As we have said, a key driver of our specialty growth is our innovation pipeline.

Our first-quarter Vitality Index was 24%, relatively consistent with our overall target of approximately 25%. Additionally, margins from new products increased 80 basis points over last year's first quarter and are accretive to overall segment margins. Our successful Innovation pipeline is a key driver for margin improvement and sustained sales growth as more new products reach commercialization. An example is the success we're having in the adhesives and sealants markets as a result of the introduction of the expanded proprietary hydrophobic polymer portfolio.

We are pleased to see commercial orders in the U.S. and are beginning to build a customer base in Asia Pacific and Europe. Additionally, laminates and films launched a new line of high-fidelity stone laminates for RV countertops in Q1. We already have a number of placements with several major RV brands which will be in models beginning in May.

These new designs represent the latest trends in large-scale dramatic stone. They utilize our new polish-surfacing technology, which results in an enhanced natural look and feel. In addition, they are coated with Omnova Solutions' superior surf(x) coating, resulting in high-performance durability. We are confident that the innovation pipeline is well-positioned to fuel our growth for many years to come.

Performance materials had a challenging quarter, as it is going through the fundamental transformation in 2018 as we transition away from the commodity coated-paper market in our effort to increase margins and cash flow. Volume was down year over year, which was not unexpected, primarily driven by sales declines in coated paper. Sales [ph] timing was unfavorable in the first quarter for a few of our higher-margin performance material lines of business. On the other hand, sales to the carpet market were strong, reflecting the success of a new product we launched at the end of last year.

You will hear me talking more about a few of the other lines of business in performance materials that provide attractive margins and some growth potential. Our antioxidant business is one of those. We just recently improved the environmental capabilities of our Chinese plant. As a result, we expect to be able to expand production and lever our strong Wingstay brand name to continue to drive profitable growth.

Similarly, our reinforcing-resins business is focused on providing structural support to rubber end-use applications. We have recently identified additional opportunities in the U.S. for growth of this product providing a differentiated solution to the rubber industry. Lastly, our coated-fabrics business, based in Thailand with sales in Asia and the U.S., is a leader in the transportation market, where we see growth potential.

For example, we just recently introduced new products under our Nautolex brand for marine applications that provide superior weathering properties. These lines of business are included in the performance-materials segment because they focus on the more mature markets where there are fewer opportunities for higher growth and product innovation. That does not mean that these businesses cannot contribute to Omnova's overall growth and profitability; they will. It is our approach to managing them, focusing on agility, selective innovation, margin improvement, and cash generation, that will help us be successful.

We're going to keep executing on performance-materials initiatives all year long as we continue to transform our business by exiting low-margin market segments that challenge our overall profitability. In terms of impact on our manufacturing operations, in the near term, we will reduce production capacity and costs in our Green Bay, Wisconsin, facility by modifying shift coverage. With respect to our medium- to longer-term plans, we will continue to evaluate our footprint to ensure that we fully support our specialization growth while improving global-capacity utilization and cost competitiveness. From a portfolio-optimization perspective, we are pleased to announce another small addition to our portfolio.

During March we invested an extremely modest amount to purchase the technology and customer list from an industry player who chose to exit a smaller-volume line of business serving the coatings, adhesives, and sealants space. This technology is complementary to an existing Omnova line of business and will be produced in one of our current facilities with no additional cost. Its addition will link capacity utilization and customer penetration. With respect to our final strategic priorities, our One Omnova functional excellence initiative, we have continued to reduce complexity and provide a more agile and flexible organization.

We have targeted $3 million of annualized savings during 2018, which we are on track to deliver, as evidenced by our reduced first-quarter SG&A spend. I am often asked where we are with respect to our turnaround. My answer is that we are still early in our journey to be a true specialty-solutions provider with a balanced portfolio. We believe we have all of the elements in place, including our revamped sales, marketing, and innovation processes, supported by our proved One Omnova structure.

We are seeing some success, with five straight quarters of year-over-year volume growth in our specialties, continued cash generation, and improvements in leverage But to be clear, we will be successful when we are consistently delivering on all the elements of our strategy. We believe the hard decisions we've made in our performance-materials segment, the beginnings of success in specialty, operational excellence progress, and the portfolio actions we have taken have positioned us well. After the first quarter our outlook for fiscal 2018 remains unchanged. We are expecting our fourth year in a row of adjusted EPS growth.

That growth will come from our specialty businesses supported by continued new-product development success and a robust pipeline of commercial opportunities. 2018 will be a year of transition for performance materials as we right-size the business to position it for long-term success. Given that Q1 is our smallest and most volatile quarter, we believe it would be premature to increase our estimates for our full-year performance based solely on strong Q1 specialty results. In summary we are seeing 2018 as an acceleration toward the new Omnova -- a company with a true specialty-solutions portfolio.

2018 will be a year where we will execute on our specialization strategy while further de-emphasizing lower-margin business lines in the performance-materials portfolio. We remain committed to consistently driving increased shareholder value through specialty growth and increased cash and earnings over time in our performance-materials segment underpinned by an agile, flexible, and cost-effective foundation to support our strategy. Thank you. Paul and I are ready to address any questions you might have.

Questions and Answers:

Operator

[Operator instructions] First we go to the line of David Begleiter with Deutsche Bank. Your line is open.

David Begleiter -- Deutsche Bank -- Managing Director

Good morning. Very nice quarter. Paul just on performance materials, given the challenging results in Q1 on an earnings basis, how should we think about the possibility in Q2 and the rest of the year in the segment as you try to transition from coated paper?

Anne P. Noonan -- President and Chief Executive Officer

Yeah, basically performance materials was a bit of a mixed bag in Q1, so there were a couple of moving parts. First of all our raw materials, so [Inaudible] raw-material escalation occurred, which, as you know, takes us a while with a lag on our index pricing to come back. So we will recover that. If we look at tire cord and carpet, that's the same situation -- paper tire cord and carpet, all of that is the same situation.

The one thing that we weren't expecting was that our volume was down a little bit in antioxidants, reinforcing resins, and coated fabrics. Now we fully expect that to return because [inaudible] little bit of lumpy in demand, but looking at customer by customer we expect that to come back. So overall on performance materials, what we've said, we're looking at the footprint, we're and a lot of op-excellence initiatives, we're looking at our customer mix and accelerating the higher-margin business so we expect to continue to work those initiatives as we go throughout the year. Clearly Q1 is always a bit of a challenge, as you know for us, David.

Operator

Next we have the line of Edward Marshall of Sidoti & Company. Your line is open.

Edward Marshall -- Sidoti & Company -- Analyst

Thank you, morning. So I was looking at specialty solutions as driven by oil. I'm wondering if there is something unusual about the mix with more oil and gas. Is it more profitable for you? Less profitable? How do I think about oil and gas versus the rest specialty segment?

Anne P. Noonan -- President and Chief Executive Officer

Yeah, Ed, you're right on. I mean, oil and gas has always been one of our most profitable businesses. And there were a couple of factors that went on there. It did exceed our expectations.

The market recovery was a little higher than we thought, and also we did a couple of small acquisitions last year that are starting to pay off, so they really come in a little stronger than we thought and, frankly, we've an easy comp year over year when you compare it to Q1, but it is a richer mix when we have oil and gas outperforming versus the rest. But I will say several of our other high-margin segments did perform as well if you take into account our laminates, our elastomeric modifiers, home and personal care, so it was a pretty strong mix overall in Q1 here.

Operator

Next we have the line of Atha Baugh at MGX Asset Management. Your line is open.

Atha Baugh -- MJX Asset Management -- Managing Director

Thank you for taking the question. I guess I'm kind of focused on your cash-conversion cycle right now. A lot of things going on obviously on the political front and just in terms of some of your feedstocks and you made the debt repayment during the quarter. First of all, are you still seeing, I mean, are your turns still in an area where you feel it's positive, AR, inventories, things that of that nature? And then ultimately [Inaudible] do you still think the better return on your investment it is actually debt repayment now in this environment? I know multiples have been high, but, and that helps for debt repayment.

Paul DeSantis -- Senior Vice President and Chief Financial Officer; Treasurer

Yeah so, from our point of view, and we made the comment in our earnings script that working-capital days had improved. We expect to continue to improve those, so we've set some targets over the next few years to write to reduce our working-capital days that are deployed in the business and we've geared up internally with a number of process changes and the like. We've also added working-capital days to our extended plan to make sure that we all remain focused on it. So our goal is to continue driving working capital down.

In terms of debt repayment, because of our net operating loss carry-forwards in the U. S., every dollar that we save from interest expense drops straight through to the bottom line in terms of cash flow, and so from our point of view, as we've looked at our other alternatives, we think that that's a fairly compelling alternative right now. We did just refinance our debt and reduce the interest rate, so we're monitoring or uses of capital as we go forward.

Operator

And next we have the line of Curt Siegmeyer of KeyBanc Capital Markets. Your line is open.

Curt Siegmeyer -- KeyBanc Capital Markets -- Analyst

Hey, good morning guys. Just to follow up on performance materials. You talked a little bit about the raw-material headwinds and your expectations to catch up with that sometime here in the near future. Combining that with the exited lower-margin product lines that you expect to kind of work through this year, how should we think about margins for that business just in terms of -- I don't get the sense that you're expecting a material improvement by any means, but you are divesting some of the lower product, lower-margin lines and facing some puts and takes there, so just kind of wondering, relative to last year, if you would expect any improvement by year-end.

Anne P. Noonan -- President and Chief Executive Officer

I would say in the long term we definitely expect improvement as we transition out of the lower margin, and we've always said we're targeting over 10% in that segment. In the near term, with so many moving parts, I would not expect an improvement in it year over year because we're still -- paper came in in Q1 about where we thought between the transition volume that we're working with our customer to basically transition out of our volume. And our specialty, that came in close. We expect that as we go throughout the year as we said, we'll catch up on the lag on raw materials and tire cord and carpet.

And then as the others increase and we push toward acceleration, I think it'll take a year or so to really push harder on those higher-margin businesses. So this year I would not expect it to be higher in performance materials but there are a lot of moving parts with operational excellence as well.

Operator

Next up we have the line of Jon Tanwanteng of CGS securities. Your line is open.

Jonathan Tanwanteng -- CJS Securities -- Managing Director

Good morning. Thank you for taking my questions, and nice quarter. Mix was down in specialtIes year over year. just maybe more specifics on what drove that and how you expect that to play going forward?

Anne P. Noonan -- President and Chief Executive Officer

Sorry, Jon, I missed the front end of your question. Would you mind saying that again?

Jonathan Tanwanteng -- CJS Securities -- Managing Director

Yeah, there was a headwind in specialties from your mix and I was just wondering what drove that and how you expect that to play out going forward.

Paul DeSantis -- Senior Vice President and Chief Financial Officer; Treasurer

So the headwind on the mix in specialties was because of the underlying mix in oil and gas, in the oil and gas business.So we were selling some -- the headwind part of it was that we're selling more -- we have a broader product range. Some of the new products that we're selling had little lower margins than the old product range, but overall the entire business is accretive to mix in general, but when we calculate it by the segment you'll see that it was slightly unfavorable. And so, from a go-forward expectation, we expect to continue selling a similar mix of product going forward in oil and gas, however, we started selling that last year so we'll see that negative-mix effect decline a little bit over time.

Operator

Next we have the line of Laurence Alexander of Jefferies. Your line is open.

Analyst

Yes, hi. This is Nick [Inaudible] on for Laurence. Good quarter. So just a quick question -- you touched on butadiene before, but I was wondering, are there any other areas of your raw-material basket where you might be seeing inflation?

Anne P. Noonan -- President and Chief Executive Officer

Well, we have been seeing some inflation in styrene, but we expect for the U.S. that to go down in March, to start turning downwards. I think with some of the turnarounds that are planned in Europe and Asia Pacific it'll probably take more like May before that start turning down. But styrene hasn't had the excessive escalation as butadiene has.

It's a little bit more predictable but we have price increases planned to address that.

Operator

[Operator instructions] Again next we have the line David Begleiter of Deutsche Bank.

David Begleiter -- Deutsche Bank -- Managing Director

Thank you. Just on your carpet business, I know not all of the business is indexed. So how is the pricing actions going in the non-indexed portion of your SB latex business for carpet?

Anne P. Noonan -- President and Chief Executive Officer

Well, most of our carpet is indexed, in fact, all of it is. But for the rest of the business we have other SB business in our specialties, etc., where we do not index and we've demonstrated our ability to recover that and have price increases out right now to address that, so there's always a little bit of a lag as our customers are able to pass that price down through their value chain, but we've basically been pretty consistent in our execution around price across the last year or two, I would say.

Operator

And it looks like we do have another follow-up from the line of Jon Tanwanteng of CJS securities. Your line is open Sir.

Jonathan Tanwanteng -- CJS Securities -- Managing Director

Hi. Just wanted to clarify -- you mentioned lower volume growth year over year in Q2 specialties. Is that simply because of a tougher comp or are you seeing some kind of slowdown in momentum in any area of your business?

Anne Noonan -- President and Chief Executive Office

No, it's purely a Q2 comp. It's just it was so low for oil and gas in the Q1 2017. We do not expect a slowdown in our oil and gas. We expect it to be at about the same rate or higher, continuum with the market recovery.

Operator

Next to the line of Edward Marshall of Sidoti & Company. Your line Is open.

Edward Marshall -- Sidoti & Company -- Analyst

I want to talk about the specialty business a little bit longer term, I mean, the Vitality Index has been pretty good. The rate of investment is probably higher today than it might be in the future and I'm just curious. If the investment to fuel growth, whether it's price, whether it's maybe difficult mix today or other types of margin pressures, I'm wondering where you are today versus what you think the business can run at an optimal level when you think about the margin, with the respect of the investments that you're putting in to fuel that growth.

Anne P. Noonan -- President and Chief Executive Officer

Yeah, I think with respect to investment, you know we've put a lot of it in. For the last two years, we've been doing a lot of commercial excellence and innovation as we talked before, on investments, and it's really just starting to come to fruition. With respect to any significant capital investment, we do not have a significant investment coming in the future, so we really have a lot of operational leverage on any growth we get at all in our specialties, which is where we've been really focused, and I expect the growth moving forward to be pretty consistent where we've said it would be -- that made mid- low-single-digits kind of thing. Growing with time margins will continue.

I think we have strong margins at our specialty solutions already, and we will continue to drive those specialty margins. There's no reason to believe why we wouldn't drive those up. Our innovation pipeline is designed to be richer than our base business, so the idea is that it fuels the growth in the future at a higher-margin level.

Operator

At this point, we actually have no further questions [Inaudible] in queue by phone.

Anne P. Noonan -- President and Chief Executive Officer

OK. Thank you for your questions. I would like to leave you with the following summary thoughts. Our specialty segment is showing growth in both profitability and volume.

It is our goal to do this more consistently over time and although there is still work to be done, we are making steady progress. Performance materials is going through a transitional year as we exit the commodity coated-paper market, but there are sustainable higher-margin businesses in that portfolio, which we expect will continue to the forefront as performance material evolves. And our 2018 guidance is unchanged. We continue to expect adjusted EPS growth for the full year.

Thank you for taking time to participate in our first-quarter earnings call. We look forward to speaking with you next quarter to review continued progress against our strategic objectives in driving the business to a premier global specialty-solutions company. Thank you.

Operator

Ladies and gentlemen, a digitized telephone replay is scheduled today at 1 p.m. Eastern until April 11 of 2018 at 11:59 p.m. Also, an audio replay will be available on the Omnova Solutions website at www.omnova.com until noon Eastern, also on April 11 of 2018. That does conclude the conference for today.

We again thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

Duration: 28 minutes

Call Participants:

Anne P. Noonan -- President and Chief Executive Officer

Paul DeSantis -- Senior Vice President and Chief Financial Officer; Treasurer

David Begleiter -- Deutsche Bank -- Managing Director

Edward Marshall -- Sidoti & Company -- Analyst

Atha Baugh -- MJX Asset Management -- Managing Director

Curt Siegmeyer -- KeyBanc Capital Markets -- Analyst

Jonathan Tanwanteng -- CJS Securities -- Managing Director

Analyst -- Jefferies

Anne Noonan -- President and Chief Executive Office

More OMN analysis

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.