Earnings Call: Q1 2018

Oct 4, 2017

Welcome to RPM's International Conference Call for the Fiscal 2018 First Quarter. Today's call is being recorded. This call is also being webcast and can be accessed live or replay on the RPM website at www.rpminc.com. Comments made on this call may include forward looking statements based on current expectations that involve risks and uncertainties, which could cause actual results to be materially different. For more information these risks and uncertainties, please review RPM's reports filed with the SEC. During this conference call, references may be made to non GAAP financial measures. To assist you in understanding these non GAAP terms, RPM has posted reconciliations to the most directly comparable GAAP financial measures on the RPM's website. Following today's presentation, there will be a question and answer session. Please note that only financial analysts will be permitted to Please go ahead, sir. Thank you, Christine. Good morning, and welcome to the RPM International And Investor Call for our fiscal 2018 first quarter ended August 31, 2017. On the call with me today are Rusty Gordon, RPM's vice president and chief financial officer and Barry Slifstein, our Vice President of Investor Relations. Today, we'll discuss our first quarter results and provide guidance for the balance driven by 2017 acquisitions and solid organic growth in our Specialty And Industrial segments. Better leverage as a percent of sales in the SG and A line through cost reduction actions from last year helped to offset much of the anticipated higher raw material costs and some of our price increase actions started contributing as well towards the end of the quarter. The severe hurricane season will undoubtedly perpetuate the challenging raw material environment throughout the second quarter. Sales in our Industrial segment increased 8% in the quarter, driven by prior year acquisitions, and organic growth of 3.2%. Good growth came from our European and Canadian businesses, while construction markets in the U. S. Were a bit soft. We continue to see a significant decline in Brazil in our company serving oil and gas markets, which has been consistent with their results over the last couple of quarters. EBIT results for the Industrial segment reflect a combination of higher material costs, unfavorable product mix, higher distribution expenses, and disappointing driven mostly by last year's acquisition of touch and foam at DAP and SPS at Rastolium in Europe. Organic sales were down slightly, which is consistent with recent trends across the industry, as evidenced by softer consumer takeaway in the paint category, across retail customers. A good point a good portion of higher raw material costs were offset by cost reductions in SG And A resulting in an EBIT increase in our consumer segment of 3.5%. Sales in the specialty segment increased 6.9 percent, driven by recent acquisitions and solid organic growth of 3%. Sales were particularly robust in a restoration services company due to the immediate response efforts to Hurricane Harvey and very strong growth at powder coatings, wood treatment and wood preservative businesses. We saw strong leverage as we're able to more than offset higher raw material costs with SG and A cost reductions, including the impact of the closer lag year of Thanks, Frank, and good morning, everyone. I will review the results of operations for our fiscal 2018 first quarter then cover some August 31, 2017 balance sheet and cash flow items before turning the call over to Rusty, who will provide more detail on our guidance for the balance of increased 7.5% from last year. Organic sales increased 1.8%, acquisition growth added 5.4% and foreign currency translation increased sales by 0.3%. Industrial segment sales increased 8% quarter over quarter to $729,800,000. Organic sales increased 3.2% Acquisition growth added 4.3% and foreign currency translation increased sales by 0.5%. Consumer segment sales increased 6.8 percent to $427,100,000 Organic sales decreased 1.2%. Acquisition growth added 8.1% and foreign currency translation reduced sales by 0.1%. Specialty segment sales increased 6.9 percent to $188,500,000 from $176,300,000 Organic sales increased 3%, acquisition growth added 4.1% and foreign currency translation reduced sales by 0.2%. Consolidated gross profit increased 3.6% to $572,000,000 from $552,000,000 last year. As a percent of net sales, Gross profit declined 160 basis points due principally to higher raw material costs and an unfavorable shift in mix. Consolidated SG and A increased 2.7 percent to $394,500,000 from $384,100,000 last year. The increase was largely driven by acquisitions, higher healthcare costs, and higher freight expense due to increased sales volumes, partially offset by lower bad debt expense As a percent of net sales, SG and A declined 140 basis points to 29.3% from 30.7%, reflecting last year's cost reduction actions and better than company average operating leverage on last year's acquisitions. Consolidated earnings before interest and taxes, EBIT, increased 6.1% $177,600,000 from $167,400,000 last year on higher sales and modest increases in SG Industrial segment EBIT increased 0.4 percent to $91,500,000 from $91,100,000 last year due to higher sales, which was largely offset by higher raw material costs, unfavorable product mix and disappointing results in Latin America. Consumer segment EBIT increased 3.5 percent to $72,600,000 from $70,100,000 last year, principally due to acquisition sales growth and better SG and A leverage, partly offset by lower gross profit margins on higher raw material costs. Specialty segment EBIT increased 8.9 percent to $33,000,000 from $30,400,000 last year, due to solid organic and acquisition related sales, combined with SG and A leverage, partially offset by higher raw material costs. Corporate other expense of $19,500,000 declined from $24,100,000 last year. The decrease is predominantly attributable to lower pension expense and outside professional services fees. Income taxes, the effective income tax rate was 24.7 percent for the 3 months ended August 31, compared to an effective income tax rate of 23.6 percent for the 3 months ended August 31, 2016. Last year, we experienced a large discrete tax benefit from share based compensation as we adopted ASU 2016-nine. This year, we had a slightly lower discrete benefit related to foreign tax credit planning and the corresponding reduction to deferred tax liabilities. The balance of the of $116,400,000 increased 3.2 percent from last year's 112,800,000 Current quarter EPS of $0.86 per share compares to EPS last year of $0.83 per share. And now a quick look at the cash flows and capital structure. Cash used by operating activities was $26,100,000 this year compared to cash provided by operating activities last year of 6,500,000. The decrease was principally attributable to the increase in sales and the timing of receivable collections this year versus last year, and the timing of accruals associated with customer rebates and income taxes. Total debt as of August 31, 2017 was $2,100,000,000 compared to 1 $700,000,000 last year. The increase is largely attributable to cash used for fiscal 2017 acquisitions of $254,000,000. The payment to the 524 GTrust in December 2016 of $102,500,000, the pre funding of the December 2017, five twenty four G Trust payment of $119,000,000 in May and the pre funding of the fiscal 2018 pension plan contribution of $52,800,000 also in May. Included in total debt for this year is $254,100,000 of short term debt reflecting the upcoming maturity in February 2018 of our 6.5 percent $250,000,000 bond. With that, I'll turn the call over to Rusty. Thank you, Barry, and I'll provide some color on the balance of our fiscal 2018 year. Let me start with where which included raw material costs going up, which we offset with tighter SG and A controls, Now as we roll forward to the 2nd quarter, we've had hurricanes, which have led to higher raw material costs in the 2nd quarter, And that's also disrupted some of our sales activity most recently. So as the areas of country that have been impacted by hurricanes rebuild in the back half of the fiscal 2018 year and into fiscal 2019, We do expect increased sales into these affected areas. Additionally, we are going to continue to increase prices in response to the raw material inflation. I'll now address each segment specifically. Let's start with the Industrial segment. In the first quarter, we had a nice balance of acquisition and organic growth. As you've heard, We've had strong sales in the Europe and Canada. We expect that to continue. Also, we expect, poor economic conditions to continue in Latin America, most specifically in Brazil. Our sales in energy markets, which most impacts our industrial coatings business, seem to be nearing the bottom and we do continue to expect a rebound at some point in our second half of the fiscal year. We do expect commercial construction in the U. S. To continue to provide a favorable market for the balance of the year. Even though most recently, we haven't seen the forward momentum in U. S. Construction that's occurred in the recent years, We do see some promise, especially in the south with the rebuilding activity from the hurricanes. So for the balance of the year, we expect the Industrial segment to grow sales in the mid single digit range. Additionally, we continue to incur expenses relating to the ongoing integration of Flow Creek and Euclid into the newly formed Euclid group, and we're very focused on driving improved operating leverage throughout the entire industrial segment. And this will involve future realignment to generate additional cost savings and efficiencies. Next, I'll move to the Consumer segment. In the first quarter, we got significant contribution to sales from acquisitions And this offset some weaker organic sales growth that you heard about earlier. The economic conditions continue to be favorable for the consumer segment. When you look at residential housing, employment numbers, consumer confidence. So for the balance of the year, we would expect our consumer segment to grow sales in the mid of acquisition and organic growth additional good volume in that business in the 2nd quarter. Powder coatings have been growing nicely as have our wood protection products, which include preservatives and wood treatments. On the negative side, for the rest of the year, we are going to be affected in our edible coatings business by a patent expiration But nevertheless, for the balance of the year, we expect our specialty segment to grow sales in the low to mid single digit range. So overall, for EPS in the range of $2.85 to $2.95 a share. Now we will be you. You. Our first question comes from Frank Mitsch from Wells Fargo. Please go ahead. Hi, good morning. It's Azan for Frank. Hey, Azan. Hello. So with such an array of raw materials, can you guys elaborate which specific raws give you most concern at this time? Sure. The raws that have had the greatest impact on in the quarter, we're in the neighborhood of acrylic resins, epoxy resins, silicone, some isocyanates, We had some actually shortages, which interrupted our ability to deliver sales in categories like MMA, Most of the shortage issues have been corrected. And that's good news. We had a backlog in some of our MMA product categories for sealants and flooring building because of supply. And I think there was some anticipation that raw materials would be easing think the hurricane activity and its impact on the North American chemical industry, suggested it'll still be an issue for the coming quarter or 2. Okay. And within Consumer, could you provide an update as to what you're seeing, with the Kirker business? Thanks. Sure. We have talked a lot in the past about Kirker and it's, decline in sales and earnings and the Kirker business has new management. It's stabilized, and it's in the grand scheme of things, not very material. And it either contributed to sales or earnings growth or decline in the quarter relatively flat and stable and rebuilding business with a better leadership team. Okay. Thank you guys. Thank you. Our next question comes from Rosemarie Marbelli from Gabelli and Company. Please go ahead. Thank you. Good morning, everyone. Frank, I was wondering if you could touch on the consumer side. The twins are negative for the paint categories. We have heard that from everyone, but you are not in architectural pains, you are focusing mostly in small projects. So can you give us some details as to what you are seeing in your neck of the wood? And why is it done? Sure. I think in the Consumer DIY segment for RPMs, our results have been relatively comparison to a strong results of a year ago, but also in comparison to our most directly comparable public peer, who's consumer segments about $1,600,000,000. And for each of the March 30 quarter and June 30 quarter end for them, their organic sales were down 11% whereas we're down 1%. So not only are we holding our own, we're gaining some share in certain areas. I think in general, there has been a challenge weather wise in terms of a very wet spring and a very wet June. And some questions as to whether some of the painting season this year was lost a little bit to weather. I can also tell you at the big box retailers, I think Berry has an interesting trend relative to statistics they put out just broadly on their categories by a dollar amount. Yes. The, same store sales that are large retailers is generally been in the mid single digits. But when you scroll down a bit deeper, you discover that it's the ticket items that are $900 and above that are driving a lot of that growth. They're up in the close to double digit range, whereas items $50 and below are only growing in the 1% to 2% range. So those are some of the statistics we look at. But in terms of market share, in terms of new product introductions and comparatively to the public peers that we can see data on, we're more than satisfied with the results in our consumer business on a comparative basis. On an internal basis, we are not achieving the sales growth that we consistently like to see and we are consistent, we are working on that. What do you think you can do? I mean, vis a vis your peers, we are talking mostly about architectural paint projects being given to contractors. So are you seeing that your small projects like spackling and other type of small products that you are selling are also going to contractors as opposed to the individuals doing it? No, we're not in the architectural paint business. And so I don't know that we're directly impacted by the competition there between the movement between DIY and paint stores. I think it's interesting that the largest paint company in the U. S. Talks about, the strength of its paint store models versus its competitors, which happen to be our biggest customers in terms of home centers, discounters and hardware stores. So we continue to serve our customer base quite well in the small project paint, patch and repair and sealant adhesive categories in which we compete Okay. And then lastly, if I may, on the Industrial side, you mentioned that there were some areas, performing wells and others being weak. Could you give us a little more in terms of those sectors in each categories? Sure. We've had pretty solid strength in, construction, North American construction, and it's been a little choppy. I suspect most of that is related to the hurricane activity, Texas and Florida are 2 huge states for us, both at the consumer level relative to the population and the number of customer stores we serve, but also very much in the construction markets And so there's some choppiness there. The backlog of activity that our businesses, like Tremco or drive it indicate they have would suggest that it's temporary and that we've got pretty solid performance coming up Europe is doing better, and Canada are doing better relative to where they were. And as you noted, FX noted in our results, FX was essentially neutral. It's the first time in 3 years where we haven't had a negative impact of FX sales and earnings. The biggest weakness for us regionally was in Latin America. Almost universally, Latin America has been a challenge for us Obviously, our biggest presence there is Brazil and that continues to be a troubled economy. Okay. Thank you. Thank you. Our next question comes from Steve Byrne from Bank of America. Hey, good morning. This is Ben Gautostainer on for Steve. Quick question about the SG and A commentary. Can you just discuss in more detail some of those SG and A reduction initiatives are they still ongoing and how are you approaching this? Sure. We had a number of initiatives that, I think were known last year. We closed an underperforming operation in the Middle East. We closed underperforming operation in Europe. We had a year end rift that affected about 250 people across different parts of RPM. And as we look into fiscal 2018 and a little bit into fiscal 2019, we have continued efforts particularly focused in our industrial segment where we will be combining some businesses and realigning some businesses in ways that will allow us to be both more globally competitive in certain markets and address our SG and A expense base at the same time. Okay, that's helpful. Thank you. Thank you. Our next question comes from Ghansham Panjabi from Please go ahead. First off, how are you thinking about core growth for 2018 by segment? And how should we sort of think about that breaking out between volume and price? I mean, you obviously have a lot of initiatives on the pricing side underway? Just trying to figure out the cadence of that as the year progresses. Sure. In the Industrial segment, we're generating core growth in 3%. And I suspect it might be a little weaker in the fall months and a little stronger afterwards just because of some of the choppiness we're seeing relative to the hurricane activity, it's hard to know. But, there was almost a standstill in Texas and, in Florida, and we're starting to see things pick back up there. Our specialty segment businesses with the exception of the edible food coating business because of the patent expiration. So the good news there is the management team has maintained so far 100 percent of their market share, but obviously on a lower sales dollar base and a lower profit base. So that will be year over year negative the rest of our specialty segment, will be kind of in the low single digit organic growth rate with the exception of Legend Brands who is, selling most everything they can make in relationship to their water restoration and air handling and dehumidification equipment, which is heavy demand right now. On consumer, we see that beginning to pick up modestly in the coming quarters. And I think in the second half, we'll be staring at much easier comps relative to some of the weather issues, rain issues that we talked about in the spring of 2017. And, so hopefully that gives you a sense of how we're thinking about organic growth On a consolidated basis, I think across RPM and most of the pricing and was in August. Some of it was initiated as of September, on average, it's in the 2% to 3% range. On a segment basis, for competitive reasons, we would not provide that data. That's super helpful. And just as a follow-up on the second quarter impact from weather and high raws, etcetera, how should we think about the net impact on the quarter specifically as it relates to the progression through the back half of the year from an earnings standpoint? Thanks so much. Certainly. So I think we'll continue to see a gross margin challenges in the coming quarters. You should also expect to see SG and A year over year improvement as a percent of sales. As Rusty indicated, I think we're comfortable with the guidance that we've provided, even in light of some of the unanticipated disruptions around the hurricanes. And we'll certainly keep people up date, if that changes throughout the comes from Vincent Andrews from Morgan Stanley. Please go ahead. Thank you and good morning everyone. Maybe just another question on the SG and A program. Frank, just curious if you haven't quite quantified what your goals are for this year. So I'm just wondering if there's a range of outcomes you have in mind depending on how the year progresses and whether you have the potential to pull some things forward from 'nineteen or push some things out into 'nineteen depending on how things play out. But any more detail you can give us numerically on what's going to happen from an SG and A perspective in terms of the programs you're working on? Yes. We're, I think A, not really in a position to do that and B, over time, I've gotten smarter about, being better about announcing what we did when we do it. As opposed to what we might do in the future. And accounting regs certainly support that. I think we look at singles of 1,000,000 of dollars a quarter in terms of the type of activity that we're looking at, mostly focused in industrial. So nothing worthy necessarily of calling out. If there are specific items that are sizable enough, over the next six to eight quarters to call out specifically in terms of restructuring or production activities, we will call them out and we will adjust them out. Okay. And just as a follow-up, obviously at a very successful year and M and A last year. How's the pipeline looking now? Sure. I think we've completed a couple of small acquisitions. Here in the first quarter. And there's a pretty good backlog of kind of the small to medium sized acquisition activity out there. And then, of course, there's a lot of, across all industries, a lot of multibillion dollar transactions. And I think also in most industries, not much in the middle. And that's kind of the M and A landscape that we see. Okay. Thanks very much. Thank you. Our next question comes from Kevin McCarthy from Vertical Research. Good morning. How are you? So your gross margin declined 160 basis points in the 1st fiscal quarter. Based on the price actions and discussions that you're having now and your view of raw materials, do you think you can close that GAAP? And if so, when might that occur? Not until the second half of the year. Okay. And is that based on price flow through or an expectation that the raw material profile will will add as the hurricane effect sees or both perhaps? I think it's a combination of both. I think it's a function of of the impact of rising raw materials, which has been happening pretty significantly across our industry and in some cases, surprisingly, that impacted us and something we anticipated in the first quarter. I think that the easing of that which in terms of easing up of capacity and the elimination of some of the shortages we saw is not happening as quickly as we and others in our industry thought in part because of the impact of the hurricane. So I suspect we're going to be fighting gross margin issues, certainly through the second quarter. That's helpful. And then last one, if I may, for Rusty, what would your expectation be for the tax rate in the second quarter and beyond? Sure, Kevin. Yeah, our outlook on the tax rate really hasn't changed for fiscal 2018. We're still expecting the tax rate to be in line with last year's rate. So in the 26% to 27% range, we did have a better slightly better than expect rate in the first quarter due to some tax planning that's gone on with all the talk about tax changes going on in the media. We did that. But overall for the year, we're still the same as we were in July. Very good. Thank you so much. Our next question comes from Arun Viswanathan from RBC Markets. Please go ahead. Good morning. Great, thanks. Good morning, Frank. How are you? Just a quick question on acquisitions. So it looks like acquisitions were about a 5% or so contributor to the top line in the quarter. Is that the right level that should affect the rest of the year? And then, it looks like the margins were slightly below our modeling, was that potentially because the acquisitions related charges? And so should margins pick up through the year or is that more raws driven? First of all, the revenue base will mitigate, after the second quarter as the largest chunk of our acquisition activity, happened in the second half of last year. So kind of January through the spring. Quarter, but it should have a comparable impact in 2Q. The performance to the bottom line of our acquisitions has been, as expected. Certainly, there are good strategic businesses that we've integrated that is ahead of schedule in every case. But they were also impacted like the rest of our businesses, by raw material issues. But in general, those have been, well integrated and they're performing at or above our original expectations. And then you also noted that you do expect some increased volume from hurricane rebuilding efforts. It seems like you're expecting that to come through in the back half of the fiscal year. Is that right? Or is it coming through earlier than you expected? Or how do you expect that kind of flow through? It's hard to say. We have a seeming growing backlog in certain of our construction businesses. And I think the challenges are, timing in terms of when certain things are ready and staging. And I can tell you across the construction industry and like commercial construction, one of the other bigger challenges is, capable contractors and labor. And so those are the 2 biggest factors in terms of the timing of any impact of rebuilding or remodeling or renovation. Thanks. And just as the last one, I mean, appreciate your comments on consumer and the DIY environment. Maybe you can just kind of reiterate what you're seeing there and your outlook for the rest of the year, specifically as it relates to DIY environment. Is there anything that you think is structural in the DIY environment to say a couple of years ago, has it increased or slowed down materially? No, again, we are facing big comps from last year. Certainly in our fourth quarter, which was disappointing a year ago, we had, 9 almost 10% organic growth. Last year in first quarter, I think we had 2% or 3% organic growth. And so that's part of it. Part of its weather. And it's also the statistic that Barry ran into reading some of our major customers where big ticket items are up in the high single digit and, items below $20 in our category and others are relatively flat. There's a lot of discussion around architectural paint, which is not an area that we're in. But I do think that there is a pretty interesting food fight, amongst the major architectural paint producers, both in terms of channel and share. And, to the extent that that's impacting us, it's hard to say it would be peripherally, but it certainly could be. But I think those are the issues we continue to focus on new product introduction and being a partner to our retail customers, versus some of our larger competitors who are in their own retail paint businesses. Got it. Great. Thanks. Thank you. Our next question comes from Silke Kueck from JP Morgan. Please go ahead. I was wondering if you've, if you've got any price or how much price you've got in your in fiscal 2017. And in general, if you announced like a 2% or 3% price increase, you normally end up getting everything? You get like half of it or what's sort of like the, the, the track record And I was also wondering whether there were any negative gross margin effects from the acquisitions? So I'll take your questions in reverse order. There were no negative gross margin effects from the acquisitions One of the negative factors on our gross margin was mix. So we had some higher revenues in some construction chemical businesses in Europe that carried lower margins than for instance some of the roofing and waterproofing lines that carry higher margins in the U. S. So it wasn't just a function of raws, particularly in our Industrial segment, mix was a big issue, but that was in essentially our core businesses, both in terms of product categories and geography. In terms of price, again, given the breadth of RPM and the number of product lines and the number of businesses, It really depends. We had virtually no price increase on a consolidated basis to 0.2 in 2017. And, on average, I think what we would hope to see across RPM beginning in August September and then carrying throughout the year, year over year is about a 2% to 3% increase. Obviously, there maybe a need to do more than that depending on what happens with raw materials from where we sit today. And then, in some cases, there have been raw material increases of 5% or 7%. In others, it's been relatively modest. And it really truly depends on the specific raw material, its availability and the price increases that we're facing. In those circumstances. And I think we've learned, over the years competitively that while it's appropriate to provide investors some color on price increase activity on a consolidated basis. It does more competitive harm than good to do so by segment. Thank you. Thank you. Our next question comes from Richard O'Reilly from Rivera Associates. Please go ahead. Okay. Good morning. Thank you, gentlemen. 2 quick questions. The first one is your comments about freight and distribution expense being higher. And I'm just asking, is this a normal cyclical, rise in expense, or is there something else going on in the trucking industry distribution industry, something secular that's changing? No, I think the biggest challenge, and this is not unique to us, think the biggest challenge in the freight area, particularly trucking, is the onset of new regulations over the last couple of years as to miles that can be driven and electronic clocking of hours and different odds and ends that have in general, risen some freight costs. And then the other issue around freight, which is a little choppy again is the disruption of the hurricanes. And so that's caused a couple of things. Number 1, it's caused some dislocation in terms of the number, the normal distribution model for us and for many of our customers, And secondly, in some instances, we have had some less than truckload shipping to meet some emergency requests to move sealants or waterproofing products or some of the water restoration products really just to position or meet customer needs around some of the hurricane restoration and renovation issues. So that's caused some some freight issues, but that's temporary. Okay. 2nd question is related to your oil and gas related businesses. I think the press release says you expect these businesses to turn positive in the second half of the year. Is that just the comps allow you to turn positive? Or do you see something, changing or improving in the end markets? I think at this stage, it's mostly the comps. We've been through 2 years of, low double digit earnings, not earnings, low double digit sales declines. You could guess in any of our categories if your sales are declining by double digits or your related earnings, And we're now seeing more mid single digit, contractions in that business. And as we get to the second half of the year. I think we're seeing things stabilize and we'll be facing easier comps And that's the right way to think about it. We're not seeing or anticipating any robust pickup in those markets. I will now turn the call back over to Frank Sullivan for closing remarks. Thank you for participating in our first quarter investor call today. We're pleased with our performance in the quarter given the challenges in the raw material area as well as some of the unexpected issues around hurricanes. We anticipate continued solid performance for the balance of the year, both in terms of organic growth and as we work through the year in terms of some of our SG and A and cost reduction initiatives and, appreciate your interest in RPM. Tomorrow, we will have our annual meeting of shareholders at the Holiday Inn in Strongsville, where we will greet about 1000 RPM shareholders. And talk to them about our first quarter results and our outlook for the year as well. Thank you for your interest in RPM and for your time on our call today. Have a great day. Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating.