GCP Applied Technologies Inc. (GCP) Q4 2018 Earnings Conference Call Transcript

GCP earnings call for the period ending December 31, 2018.

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GCP Applied Technologies Inc.  (NYSE:GCP)
Q4 2018 Earnings Conference Call
Feb. 27, 2019, 10:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Good day, everyone, and welcome to the GCP Applied Technologies Fourth Quarter 2018 Earnings Conference. Today's conference is being recorded. After today's presentation, there will be an opportunity to ask questions. (Operator Instructions)

And now I'd like to turn the conference over to Joe DeCristofaro. Please go ahead, sir.

Joseph DeCristofaro -- Vice President of Investor Relations

Hello, everyone, and thank you for joining us on today's call. With us on the call are Greg Poling, Chief Executive Officer; Randy Dearth, President and Chief Operating Officer; and Dean Freeman, Vice President and 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 on this morning's 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 the business update. Randy will discuss our commercial initiatives, and Dean's commentary will include highlights of our financial results and outlook. We are discussing these results on a continuing operations basis to account for the sale of Darex Packaging Technologies. Additionally, we deconsolidated Venezuela as of July 3rd, 2017. All revenue and associated growth rates in this discussion are stated on a comparable constant currency basis, which adjusts for the impact of foreign currency.

With that, I'll turn the call over to Greg.

Gregory E. Poling -- Chief Executive Officer

Good morning, everybody. In 2018 we performed well in our core markets. However, we were negatively impacted by both inflation and foreign exchange volatility in certain geographies, primarily in our admixture business. In the second half of the year, we successfully implemented a program to exit these low margin geographies and improve SCC's profitability and cash flow. We also initiated price increases across our businesses, which partially offset the higher-than-anticipated inflation and foreign exchange volatility. We're continuing to see the benefits of these price increases as we move into 2019.

VERIFI's commercialization gained significant traction in 2018 with the sales increasing about 40% for the year. We have a healthy pipeline for VERIFI with both new and existing customers. We are in the exciting process of integrating our admixture chemical business with VERIFI data management to provide even more value to our customers. SBM's revenue earnings and operation -- operating margins improved in 2018, and our acquisitions are performing as expected with margins that are accretive to our overall GCP margins. Adjusted EPS grew about 42% and adjusted free cash flow increased significantly as a result of our reducing our debt, lowering our interest cost, and improving our working capital.

I would like to comment on the announcement we made this morning to our shareholders. As outlined in our open letter, our Board has approved a new cost restructuring program, the evaluation and exploration of potential strategic alternatives, and continued board refreshment. We're investing in operational efficiencies, designed to improve processes and execution across our supply chain. This includes our manufacturing, purchasing, logistics and warehousing operations, and we are also implementing a redesign of our service delivery model to streamline our pursuit of combined admixture and verify opportunities. We expect this program to deliver $25 million in annualized savings, once completed over the next two years, an additional improvements in our working capital. Randy will provide more details on our supply chain strategy in just a moment.

Given the current market dynamics and our insights into the competitive landscape, we will be evaluating strategic alternatives for the Company, which may include the sale of GCP, a strategic business combination, as well as potential enhancements to the business, all of this with a view to maximizing value for our shareholders. At the same time we remain focused on improving GCP's profitability, earnings, and cash flow in 2019. We'll continue to grow our high-margin SBM business with the introduction of new products. We will improve SCC's profitability with a focus on core admixture markets, as well as the growth in VERIFI, Ductilcrete and sprayable concrete, and we are executing on the additional efficiency opportunities we've identified across our supply chain.

I would like to turn the call over to Randy for more details on these key commercial initiatives and programs.

Randall S. Dearth -- President and Chief Operating Officer

Thank you, Greg, and good morning, everyone. Our strategy of focusing on core admixture markets where we have the strong position is showing results. I'm happy to report that since we last spoke with investors, we have successfully secured a number of key admixture contracts with both new and existing strategic accounts. In 2018, VERIFI sales grew approximately 40%. We also signed 10 contracts and build a significant pipeline of opportunities. We also improved our technology for using chemicals to manage slump in-transit. For 2019, we expect VERIFI sales to grow at a higher rate than in 2018, with the significant percentage of our growth already secured with recent new business wins. Our growth plan for VERIFI in admixtures includes: implementing a redesign of our North American sales organization to integrate VERIFI into our concrete admixtures organization, the scaling production and assembly capability for VERIFI units to reduce per unit cost for margin expansion. In commercializing the next generation of our VERIFI technology, which integrates admixtures on the truck into our material management system, and is designed to more than double the value we deliver to our customers. Our forecast for VERIFI revenues remains $50 million to $75 million by 2021 with EBIT margins that contribute significantly to SCC's profitability.

I would like to report that we have substantially completed our restructuring and repositioning program that includes exiting non-profitable geographies. You may recall our estimate for total annualized savings is $25 million, with 75% of the savings benefiting SCC. We expect total annualized revenue reduction for SCC of $65 million to $75 million by the end of 2019. The revenue reduction in 2018 was about $10 million. And our estimate for total plan cost is approximately $31 million to $35 million.

This morning we announced our next step toward achieving further cost and operational efficiencies. This restructuring plan is focused on GCP's global supply chain strategy, our processes and the execution. The plan also addresses our service delivery model, primarily in North America to streamline our pursuit of combined admixture and VERIFI opportunities. We've engaged with the leading consulting firm that I've worked with successfully in the past. This firm will help GCP with our supply chain strategy and processes. Key areas of focus include manufacturing, purchasing, logistics and warehousing. This plan will help us improve our growth and our margins. And our estimate for savings associated with this new program is approximately $25 million, with about $8 million benefiting in 2019. With these two programs combined, we plan to remove about $50 million in costs from 2018 through 2020 as we reduce GCP's complexity and create a more efficient and effective organization.

Looking forward, I believe that as we continue to assess and refine our business model, we will identify further cost reduction and efficiency improvements, which will ultimately drive improved returns for shareholders.

I'd now like to turn the call over to Dean for details on our financial performance and guidance. Dean?

Dean P. Freeman -- Vice President and Chief Financial Officer

Thank you, Randy, and good morning everybody.

Just a reminder, all revenue and associated growth rates in my comments are on a constant currency basis. The fourth quarter GCP's consolidated revenues declined 2% to $285 million, and sales grew 1% excluding the exit countries. Volumes were lower than forecast, mainly due to weather in North America, which impacted SCC in particular, and continued project softness in the Middle East. In the fourth quarter, SCC sales were down 2%, to $163 million, including revenue reduction of about $10 million due to exit countries as Randy mentioned. Admixture sales declined 6%, while cement additives were flat.

SBM's revenue was down 1% year-over-year. The Building Envelope sales grew 2%, and Residential sales increased 3%. Specialty products declined 11% year-over-year due to project timing in our fire and floor underlayment businesses. GCP's adjusted gross profit declined 9% to $101 million. While we were successful in capturing price, raw material and logistics inflation and foreign exchange volatility, specifically in SCC outpaced the benefit we achieved through these price increases. SBM's gross margin was flat compared to the fourth quarter in 2017, with price capture offsetting raw material inflation. SCC's gross margin declined 300 basis points year-over-year as the business continued to be impacted by inflation pressures and foreign exchange volatility in Latin America and the Middle East. GCP's adjusted EBIT declined 16% as higher SBM segment operating income and lower corporate costs were offset by lower SCC operating income.

Rounding up the consolidated results for GCP in the quarter. Our interest expense and related financing costs were $6 million compared to $14 million last year as a result of our debt refinancing transactions. EPS was $0.29 a share, an increase of 21%, primarily due to lower interest expense and lower adjusted tax rate. Adjusted free cash flow was $44 million in 2018, increased significantly due to lower cash interest payments, as well as improved working capital management.

Taking a quick look at our key geographies for 2019. While we expect some moderation compared to 2018, our core North American market remains healthy. In EMEA, we expect growth excluding the exit countries. In Asia Pacific, we expect growth in Building Envelope and our sprayable concrete businesses. There are pockets of growth in Latin America. Broadly, we do not expect significant improvement in this region for 2019.

Last quarter we gave you an early indication of our expectations for 2019. We've now finalized our operating plan for 2019 I'd like to update you. We are confirming our expectations of approximately flat sales for 2019 versus 2018, which assumes that market growth, price capture and growth in key programs, such as VERIFI is offset by the impact of the exit countries. We expect adjusted EBIT growth of 7% to 14% on a dollar basis of $127 million to $137 million, with adjusted EBIT margin improvement of 100 basis points to 150 basis points. Adjusted EBIT forecast assumes $27 million in restructuring plan savings, impacting our P&L in 2019, and that price will offset the impact of inflation. Other offsetting expenses will include, variable incentive compensation reset, normal annual salary, inflation increases, higher pension expense, and further investments in growth programs such as VERIFI. The top end of our guidance would reflect healthier than expected project activity, the moderation of expected inflation trends, and faster than anticipated restructuring savings. The low end of the range takes into account higher than expected inflation and a slowdown in construction activity that could result from a weaker economy.

For SCC, we expect segment operating margin improvement of 300 basis points to 400 basis points due to moderating inflation, the positive impact of price increases, and the impact of country exit savings, and growth of higher margin VERIFI. For SBM, we expect segment operating margin improvement of 150 basis points to 250 basis points, due to moderating inflation and price increase.

We are forecasting an adjusted tax rate between 19% of between 27% and 29%. And as you've seen, our EPS guidance range is $1.03 to $1.14, with adjusted free cash flow guidance of $55 million to $70 million. Overall, our sales and earnings should resemble a normal seasonal pattern in 2019. The first quarter is expected to be the weakest, but the second quarter is the strongest, followed by the third quarter and the fourth quarter seasonally weaker, but stronger than the first quarter. Greg?

Gregory E. Poling -- Chief Executive Officer

Yeah. Thank you, Dean. I'd like to thank everybody for joining our call. This is an exciting time for GCP, and now we just like to take your questions.

Questions and Answers:

Operator

Thank you. (Operator Instructions) And we'll go first to Mike Harrison at Seaport Global.

Mike Harrison -- Seaport Global Securities -- Analyst

Hi, good morning.

Gregory E. Poling -- Chief Executive Officer

Good morning, Mike.

Mike Harrison -- Seaport Global Securities -- Analyst

I was wondering if you can -- we can maybe start with a little bit more color on what went into the decision to explore strategic alternatives. Was this something that shareholders will pushing for? Was it part of the long-term strategy for the Company something initiated at the Board level? How much can you tell us about that?

Gregory E. Poling -- Chief Executive Officer

Mike, I think it would be fair to say that as a management team and board, we've been looking at this landscape for quite sometime. We like the market that we're in. If we look at the competitive landscape today, and frankly feedback from our investors, we've looked at our scale, we've looked at our opportunities, we've got some terrific businesses. We now have a new technology that's being launched. We think given those parameters that this is a great time to step back and say, what's the best value creation opportunity for the Company, and that's what we're going to do.

Mike Harrison -- Seaport Global Securities -- Analyst

All right. Thanks for that. And then, I was wondering if you can talk a little bit about the restructuring program that you're announcing here. Maybe give us an update on how restructurings progressing with the 2018 plan, which I believe was a little more focused on SG&A costs in the Construction Chemicals business. And it sounds like the new program is a little more focused on logistics. Just how do they -- help on how they overlap and how you're progressing on the previous program? Thanks.

Gregory E. Poling -- Chief Executive Officer

Yeah. Let me take that, and I'll turn it over for Randy on the newer program. You're exactly right. I mean, if you remember, we had a program originally when we saw the Darex business which was eliminating stranded cost and we implemented that at the time, and in fact came in a little bit better than we thought. The program on the exit countries, and in some of the lower margin pieces of the business that we announced last year is frankly pretty much complete. We targeted about $25 million of savings, we had some fairly significant headcount reductions in that program in those countries and some of the support parts of the company that we're backing up that business. We've completed that. It's -- we got about $8 million, I think that's the number, Dean, for that program in 2018, and now the benefit start to roll through, and we're pretty much done. There might be a tail here or there.

What's happened with Randy coming into the Company, he has taken some of the experience that we have, looking at the supply chain operations and like I think, you know and the lot of investors know, a bunch of our input costs come from our supply chain. Randy has taken and look at that and work with some people that he's been within the past, and we've been working on this program for a number of months. We had the Board approve that. There is an another $25 million. This is not really a heavy duty headcount reduction program, it's really about efficiencies and how we go to market. I will just have Randy add just a little color to that see if that answers your question. But it is a separate program. The one that we had last year has pretty much ramped up and will start to flow through.

Randall S. Dearth -- President and Chief Operating Officer

Thanks, Greg. And I'll add to that. Again, this is basically looking at every aspect of our supply chain from how we produce product around the world, how we warehouse product, how we ship product, and all of which then ultimately will lead to the savings and the improvements that we've talked about in our comments, but we're excited about this, and we think that again the $25 million when once this program complete is going to be additive to our earnings and will be a much more efficient and much more effective company after everything is implemented.

Gregory E. Poling -- Chief Executive Officer

Just for everyone's information, Slide deck 10 -- Slide 10 in the deck that we presented has more information on the restructuring program.

Joseph DeCristofaro -- Vice President of Investor Relations

Does it answer your question, Mike?

Operator

And Mr. Harrison, anything further?

Mike Harrison -- Seaport Global Securities -- Analyst

Yes, just one quick last question. The press release referenced to settlement associated with the Stirling Lloyd acquisition. Can you give a little bit of color what that was and what the magnitude of that settlement was?

Gregory E. Poling -- Chief Executive Officer

Yeah. Mike, that was about $3 million. What happened here was, as we bought the company, there was some product work that we had to do when we integrate those costs flowed through our P&L, pretty much through the earlier part of '18, and we're able to negotiate a settlement around that and so we call it out. So net-net, we spent some money on the early part of the year and recovered in the back part of the year. That's really the program there, and our teams did a nice job recovering that. So that's what it's about.

Mike Harrison -- Seaport Global Securities -- Analyst

All right. Thanks very much.

Gregory E. Poling -- Chief Executive Officer

Yep.

Operator

(Operator Instructions) We'll move next to Laurence Alexander at Jefferies.

Daniel Rizzo -- Jefferies -- Analyst

Hi guys. This is Dan Rizzo on for Laurence. Could you just provide a little color on, I think you mentioned something about redesign in the service delivery model. Is it -- I mean is that just change in the sales force? Could just provide any color on exactly what that means?

Gregory E. Poling -- Chief Executive Officer

Yeah. We've done a lot of work. I think you guys know we -- the VERIFI program is being integrated into our sales process. And VERIFI has started to get some real traction, especially here in North America as we've rolled that out. And what we're essentially doing is, investing in training organization design to drive the combination of admixtures in VERIFI, while we continue to sell the VERIFI model and so admixture. So there is some redesign of territories, there is some significant opportunities for training. And Randy, have anything else to add to that?

Randall S. Dearth -- President and Chief Operating Officer

No, I think, again, this is going to allow us at the end of the day to very effectively introduce the VERIFI technology into a traditional very successful admixture business.

Gregory E. Poling -- Chief Executive Officer

And you know we have a strong sales organization around the world in our core markets for admixtures, and this is the energy that we need to put into bringing that organization up to be able to deal with both the new technologies as well service admixtures the way we have in the past. So we're pretty excited about it, so is our organization.

Daniel Rizzo -- Jefferies -- Analyst

Okay. That's actually very helpful. And then you did speak extensively, and I appreciate that about the supply chain improvements. But one thing and just a clarification, does that include going to more sourcing levels? Like are you sole-source or dual-source and then go into multi that part of the process or that's already been done and that's not really what you're focusing on.

Gregory E. Poling -- Chief Executive Officer

No, it's absolutely part of what we're focusing on. Our raw material procurement strategies are also being evaluated to the best in class, and not only here in North America, but around the world where we procure raw materials. So when this project is completed, we will be much more efficient, much more effective both cost as well as just efficiency.

Daniel Rizzo -- Jefferies -- Analyst

Okay. All right. Thank you guys.

Operator

We'll move next to Rosemarie Morbelli at G.research.

Rosemarie Morbelli -- G.research -- Analyst

Thank you. Good morning, everyone. I was wondering if you could give us a little more details on the change in the competitive landscape. Is it a change year-over-year? Is it the competitors and sales? It is -- is it the marketplace? If you could give us a little more on that particular.

Gregory E. Poling -- Chief Executive Officer

Yeah. So, I mean, the markets place, you know, is consistent as we've seen it. We see the global construction market has some variability around the world with -- that's really now what we're talking about here. There has been some significant opportunities for M&A in the space. There has been some consolidation in the space. There is opportunities for us to be involved in that change, and we thought the best way to do that was to be transparent, and say we think this industry has significant opportunities, we've got some great brands, product lines and position in the marketplace, and we want to step back and have real conversations about how to deliver that value. That's what we're talking about.

Rosemarie Morbelli -- G.research -- Analyst

Understood. If we look at the large players that I am aware of and I am most likely missing quite a few so if you could help me with that. I can think of Sika in Switzerland, I can think of single-band (ph) in French -- in France. Any of the major competitors in the US?

Gregory E. Poling -- Chief Executive Officer

I'm not sure it'd be helpful for me to speculate here. I mean, I think that many people are involved on as we look at the landscape, but this company has a terrific opportunity both from our global perspective in our technologies to deliver value, and we're going to look broadly at that as we go into the coming months here. At this stage that'd be the most I can really say about it.

Rosemarie Morbelli -- G.research -- Analyst

Okay, and I appreciate it. And the totally different question on -- as you are combining VERIFI with your admixture, do you need to change the qualifications of the sales force? Do they need to have more of a technology background? Or do they already have enough and just the training will do it?

Gregory E. Poling -- Chief Executive Officer

That's a great question. I think the core of what we have is our depth of knowledge and experience around concrete, our relationships with the customers in our core markets, how to deliver mix designs, VERIFI's additive to that, and we have the capability in the data management to be able to deliver that to our customers and our sales force. It's the building of that capability. Clearly there is some training, there is some ability to think about how to say value with our customers in a different way, not just chemistry but chemistry combined with data, but we really think we're uniquely positioned because of the people that we have in our core markets to deliver this technology. So it's not so much an upgrade, it's a -- here's how we're going to do it, here's how we get the value, let's go out and take it to our customers.

Rosemarie Morbelli -- G.research -- Analyst

Okay, thank you.

Gregory E. Poling -- Chief Executive Officer

You're welcome.

Operator

And we'll move next to Mike Sison at KeyBanc.

Mike Sison -- KeyBanc -- Analyst

Hey guys, how are you doing?

Gregory E. Poling -- Chief Executive Officer

Good, Mike.

Mike Sison -- KeyBanc -- Analyst

So just curious in terms of your outlook for 2019, adjusted EBIT growth of 7% to 14%, it's been a while, but it seems like you raised that a little bit from October. Maybe talk about the confidence in the outlook this time around and maybe getting to the high-end, how do you get there?

Gregory E. Poling -- Chief Executive Officer

I'll just make a comment Mike, and then -- and I'll let Dean come in. Frankly from October our sort of view the marketplace hasn't shifted very much, but what we have done has gotten granular on the additional cost reductions that Randy is bringing into the organization on the supply chain. So that's what sort of shifted a little bit. We still see the same market dynamics, and I'll let Dean speak to it. But on the upside, construction is good, we get some big projects that drives to the upside, and we've built in the room here if the Middle East was a little slower, some of the marketplaces don't have the construction, we're really going after the piece that we control on the cost to bring this in. But the real shift there, Mike, was on adding some of this new program that Randy is driving across the Company.

Dean P. Freeman -- Vice President and Chief Financial Officer

Yeah, that's exactly right, Greg. And Mike, I'd just point you to the confidences around assumptions. And if we think about growth assumptions, we built in very modest market growth of about a point. We've executed on our price, and that run rate continues to perform, so that's another couple points for next year. And I think we're making modest conservative assumptions about foreign exchange and continued inflation. Again as those potentially moderate, that puts us maybe on the higher end of the range.

Randall S. Dearth -- President and Chief Operating Officer

If I want to speak to the low end, we got a -- as always, we got to watch this raw material movement. But Mike, some of this exit country takes a little bit of the volatility we had last year out in some of the really volatile countries on the SCC business, so that should help us on our bracketing of the outcomes.

Mike Sison -- KeyBanc -- Analyst

All right. Great.

Dean P. Freeman -- Vice President and Chief Financial Officer

Yeah. As Greg pointed out, the bulk of the bridge is related to the optimization program that Randy in the operation teams are leading.

Mike Sison -- KeyBanc -- Analyst

Okay, great. And then, just sort of a follow-up question in terms of, your stock has reacted pretty positively today. Where do you think in terms of the businesses of the potential is still maybe a little bit undervalued relative to where the market is today and maybe it's somewhere balanced between SCC and the potential there with other cost savings or maybe talk about some of the growth potential at SBM that could drive more value going forward.

Gregory E. Poling -- Chief Executive Officer

Look, we've got a world-class SBM business and great products across the chain. We have nice brands, really good customer relationships, and we're very excited about combining data and chemistry across the concrete and cement businesses. We think those are value creators. And what we're going to do is, step back and say, how do we create that value through these review of alternatives. So we agree with this SBM business. We've got some of the best products in the industry. The organization to sell and they work. On SCC, we have a very good position, but we think managing the cost side while we build out the upside on data and chemistry combination is the strategy.

Mike Sison -- KeyBanc -- Analyst

Okay, great. And then just one follow-up question. As I read, your shareholder analysis this morning, it sounds like -- it sounds like the relationship with our Board is pretty collaborative, and maybe can you talk about what you're looking for in terms of the board nominees and how you're going to evaluate the process with them going forward?

Gregory E. Poling -- Chief Executive Officer

Let me put it a little more broadly. What we've outlined in this letter is a strategy that our Board has backed that we think drives value for the company. And I would tell you that we think we have some very good support from that from our shareholders, but I can't get into specific conversations on any one shareholder or not, but this initiative is designed to bring forward the value this company has, and that's how we're looking at it.

Mike Sison -- KeyBanc -- Analyst

Great. Thank you.

Gregory E. Poling -- Chief Executive Officer

You're welcome.

Operator

(Operator Instructions) And moving next to George Godfrey at C.L. King.

George Godfrey -- C.L. King -- Analyst

Thank you. Just following up on the initiative to increase shareholder value and reviewing all the options, two questions. One is, what is the timeframe that you're looking to complete or at least move substantially toward the conclusion of this process? And then two, is global scale ultimately the defining region for the review? Thanks.

Gregory E. Poling -- Chief Executive Officer

Good questions. I think we're going to be disciplined, diligent, and also look at the opportunities as they exist today. But frankly, I think it -- for those of you know me, when we put something on the table we move and we're going to do this in a way that gets us to the right outcome. In terms of scale, it's clearly an issue we've been having discussions with our shareholders around. We think we're competitive in the marketplace, but as our results have been, you know, there is volatility that comes with our size, and we're going to look at this opportunity to say how do we leverage the capabilities GCP has while mitigating any of the risk, that's our intention, because we think that's how you create value.

George Godfrey -- C.L. King -- Analyst

Understood. Thanks for taking my questions.

Gregory E. Poling -- Chief Executive Officer

You're welcome.

Operator

And with no additional questions at this time, I'd like to thank everyone for joining us today. And that does conclude today's conference.

Duration: 33 minutes

Call participants:

Joseph DeCristofaro -- Vice President of Investor Relations

Gregory E. Poling -- Chief Executive Officer

Randall S. Dearth -- President and Chief Operating Officer

Dean P. Freeman -- Vice President and Chief Financial Officer

Mike Harrison -- Seaport Global Securities -- Analyst

Daniel Rizzo -- Jefferies -- Analyst

Rosemarie Morbelli -- G.research -- Analyst

Mike Sison -- KeyBanc -- Analyst

George Godfrey -- C.L. King -- Analyst

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