CCC Intelligent Solutions Holdings Inc. (CCC) Q2 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Calgon Carbon Corporation's Second Quarter 2017 Financial Results Conference Call. All lines have been placed on mute to prevent any background noise and after the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I’ll now turn the conference over to Mr. Dan Crookshank. Please go ahead.

Thank you, Crystal. Good morning, everyone, and thank you for joining us for today's conference call and webcast. Our speakers for the prepared remarks portion of today's call are Calgon Carbon's Chairman, President, and Chief Executive Officer, Randy Dearth; and Calgon Carbon's Senior Vice President and Chief Financial Officer, Bob Fortwangler. Also on the call and available to take your questions later are Executive Vice President and leader of our core carbon and services business, Jim Coccagno; and Executive Vice President and leader of our advanced materials manufacturing and equipment division, Steve Schott. Management's prepared remarks today are accompanied by presentation slides. Those of you accessing the call via the webcast will find the presentation displayed in the webcast window. A stand-alone copy of the presentation is also available for download from our Web site at www.calgoncarbon.com via the link to today's webcast that can be found on the investor homepage. I'll now draw your attention to slide two. Statements made during today's call that are not historical facts are considered to be forward-looking statements and are made pursuant to the Safe Harbor provisions of federal securities laws. A list of factors that could affect the actual results can be found in the news release we issued earlier this morning and are discussed more fully in reports we file with the Securities and Exchange Commission, particularly those listed in our most recent annual report on Form 10-K. These filings, as well as this morning's news release, can also be found in the Investor Relations section of our Web site. Now let me turn the call over to Randy.

Thanks, Dan, and thank you, everyone for joining us for our second quarter earnings conference call. I will begin my remarks this morning with a review of our results and performance then Bob will take you through a more detailed look at our quarter and our third quarter guidance. After that, I will wrap up with a summary of our outlook and priorities for the remainder of 2017. So let's get started with an overview of the second quarter on Slide 3. I am very pleased to report that we delivered a 15.4% increase in sales, exceeding our expected range of 12% to 15% growth. Another solid quarterly performance in most of our North American end markets supports our view that we are climbing out of the business trough we experienced in 2016 and moving in the right direction. The new business executed well and turned in revenues and performance in line with our expectations. In our legacy business, we saw strong demand in North American end markets, in particular potable water, mercury removal and specialty activated carbon. Much of the portable water end market growth came from emerging contaminant removal carbon and equipment projects. It was ahead of our expectations. This is expected to be a contributor to sales for a while as our carbon absorption equipment backlog remains at an elevated level, standing at approximately $15 million at the end of the quarter, compared to approximately $4.5 million a year ago. Another bright spot is our industrial sector sales which saw growth over last year's second quarter. Since the beginning of the year, we have continued to see positive demand trends, particularly in North America. We are becoming more confident that our industrial sector customer activities remain poised for a recovery. More than offsetting these year-over-year gains in North America were soft sales for our legacy business in Europe and Japan, which were in line with our expectations, and $2 million in unfavorable foreign currency translation. Looking at earnings per share for the quarter. Unfavorable customer and product mix impacts, including higher than expected equipment sales and higher expected deliveries of low-margin products in Asia under contracts are winding down, weight on our gross margin. Although we fell short of our gross margin expectation this quarter, we have good reason to expect margin improvements in the second half of this year and beyond, as you will hear later. On the other hand, I am pleased to report that operating expenses at 15.5% of sales came in better than our expectations. Even though we continue to incur some acquisition-integration related costs. Not only are integration related costs winding down, but also our focus on cost control and efficiency are clearly paying off. As expected, higher borrowing costs compared to last year's second quarter contributed $0.02 to the year-over-year decline in diluted EPS. In terms of business highlights, our success in winning awards or treating emerging contaminants brought in sales of approximately $6.5 million this quarter. We also continue to win sizable awards to supply granular activated carbon to municipalities worldwide to treat drinking water. This quarter, we secured a contract to supply 2.9 million pounds for drinking water system upgrades at a water authority in Singapore. Our technical expertise and reputation for solving a customer's most demanding purification and separation problems gave us a competitive advantage in winning this award. And we expect to begin shipments towards the end of the year with majority of the shipments being delivered in 2018. On the first quarter call, I said that things are beginning to move in the right direction for us and our second quarter results only reinforce our belief that the areas of soft demand we faced in 2016 are transforming into growth drivers in 2017. So now let's take a closer look at the end market demand trends and our second quarter accomplishments. You can find these on Slide 4. Starting with the top half of this Slide, which lists our industrial sector end markets, customer sentiment is increasingly positive and the industrial manufacturing and economic data we monitor continues to point to a recovery in demand and slow but steady growth. Our base business with our traditional customers is strengthening and our market share in this sector is secure. In industrial processes, we generated sales growth in the Americas, particularly from long-standing customers in the chemicals industry. And in Europe, we are seeing positive customer demand signals in production metrics that are trending favorably. In the environmental water market, we are performing well with the stable industrial wastewater activity. As was the case in the first quarter, opportunities for remediation projects remain solid and our marketing and technical efforts are bearing fruit with the growth set of opportunities for perfluorinated or PBC projects, and remediation project sales were lower unfortunately but this was due to the completion of a significant project last year. Although ballast water equipment sales were slightly higher for the quarter compared to Q2 last year on increased activity, there is little doubt that the IMO Convention's decision to amend the implementation schedule will slow the pace of market formation and soften near-term demand growth. While we had been expecting to see measurable year-over-year revenue growth beginning in Q3, we now expect second half ballast water treatment system sales be flat to slightly higher as the vast majority of the IMO Convention retrofit market demand is expected to move out two years, mid to late 2019. Moving down the slide to environmental air. Maintenance project sales ticked up on demand from industrial customers. Particularly, our oil and gas companies. As expected, sales in Japan of activated carbon pellets to treat sulfur and nitrogen oxide emissions were below last year when we had sizable deliveries under a large contract that is nearing completion. Moving on, potable water sales in North America continue to drive growth for us. We recorded year-over-year and sequential growth on increased carbon absorption equipment sales related to the emerging contaminant treatment awards we have won this year and last. And we are continuing to win awards and create more opportunities for us to further leverage our brand, our high-value products and our reactivation services for growth in this bubbling end market. Over the past six quarters, we have won 26 [PBC] [ph] projects and five 1,2,3-TCP or trichloropropane projects for a total value of approximately $26 million. Year to date the dollar value of awards won has exceeded the value of all awards won in 2016. And the funnel of active leads is more than double the value of projects completed or being implemented. We estimate that the total projects awarded to date, will bring about 7 million additional pounds of granular activated carbon online that should lead to attractive reactivation opportunities in the future. Also in our reactivation business, we added 8 new North American custom units for reactivation customers during the quarter for a total now of 180. We continue to win new customers here as this unique services continues to be viewed and accepted by customers as a key part of the end to end lifecycle value of using granular activated carbon for treating consumer drinking water. While we saw expanded demand in North America during the second quarter, the slowness in reactivation activity in the U.K. which we noted last quarter, persisted. Our near-term outlook for the European potable water market is for slight sequential and year-over-year sales improvements in the third quarter. However, we will continue to monitor this situation. Moving down to food and beverage end-markets, after a stable performance in the second quarter, we have entered the typically high period in Europe for wine producers. This is expected to drive improved third quarter sales from your new business. And finally, in specialty carbon end markets, we had another good quarter with solid sales growth and improved order activity for respirators and metals recovery products. What's particularly exciting for us is that after several years of sluggishness, we are now seeing a resurgence in demand for commercial and military respirator products. As a testament to our proven ability to produce high quality materials, we have been awarded a grant for up to $15.4 million to construct a respirator carbon manufacturing facility at our Pearl River locations that are going to assure uninterrupted supply of these critical military materials. We are currently the only manufacturer of these materials to U.S. military and have been in the business for 75 years. We expect to begin construction of this facility in early 2018 and to have production online in 2019. I will now turn the call over to Bob who will take you through a review of our financial results for the second quarter. Bob?

Thank you, Randy, and good morning, everyone. I will begin with a review of our second quarter income statement on Slide 5. Starting at the top of the Slide, with gross margin before depreciation and amortization, you can see the slightly dilutive impact of the new business. Which, as we have communicated in the past, has historically run at a lower gross margin in Calgon Carbon's legacy business. In our legacy business, a major maintenance project at our Mississippi manufacturing facility scheduled for the second quarter, had a 0.8% point impact. Continued unfavorable product and customer mix was the largest contributor to this quarter's results. Looking at operating income at the bottom of this Slide. You can see that the net positive contribution from the new business combined with SG&A cost improvements in our legacy business, and lower acquisition related cost, nearly offset the impact of lower legacy gross margin dollars. Turning to Slide 6. I will review sources and uses of cash for the first six months of the year. We have generated year-to-date operating cash flow of $9.6 million. The spike in working capital was primarily due to increases in inventory, tax payments related to our legal entity reorganization, and unbilled receivables related to the elevated level of carbon absorption equipment projects that are booked on the percentage of completion method for revenue recognition. We have used this cash along with net borrowings of $21.3 million to fund capital investments totaling $29.9 million, covering primarily the Neville Island refurbishment and expansion projects and the wood-based carbon debottlenecking project. Cash has also been allocated to dividend payments totaling $5.1 million, or $0.05 per share per quarter. $9.8 million of other primarily reflects cash settlements of a foreign currency derivative associated with inter-company borrowings related to the purchase of a new business. That completes my review of the second quarter financial results and if you would please turn to Slide 7, I will cover our outlook for the third quarter. Starting with the left side of this Slide, we expect sales growth in the range of 25% to 29% over the third quarter of 2016, continuing this year's quarterly trend of year-over-year and sequential growth. The new business is expected to contribute of sales of $27 million to $29 million, reflecting strong demand from food and beverage customers. In our legacy business, we expect sales growth in North America from the industrial sector and from the potable water end-market, while in Europe we expect an overall slight sales improvement. Our forecast assumes a negligible impact from currency translation on legacy business sales. On the right side of this Slide, we detail our outlook for other income statement line items. We see gross margins before depreciation and amortization improving sequentially from the second quarter and in the range of 31.5% to 32.5%. Depreciation and amortization to be approximately $11.5 million to $12 million. SG&A, including research expenses as a percent of sales, are expected to be between 15% and 16% comparable to the second quarter. We expect interest and other expenses to be approximately $2.5 million and our income tax rate to be between 34% and 35%. In terms of capital expenditures, we now expect a range of $65 million to $70 million for 2017. I will now turn the call back to Randy for closing remarks. Randy?

Thanks, Bob. So please turn to Slide 8 for an updated summary of our outlook and priorities for 2017. At the halfway point in the year, we are becoming more confident in our belief that the areas of soft demand we faced in 2016 will become areas of improvement in 2017. Our North American activated carbon business is running strong in terms of projects won and order activity, and we are feeling more positive in our outlook for recovery demand from our traditional industrial customers, both here in North America as well as in Europe. As a reminder, about 30% of our sales are derived from industrial sector customers which means that a recovery in this area can really move the needle for us. Renewed demand for our respirator product is emerging as a bright spot for growth. As a result, despite the setback in the opportunity for sales growth from ballast water treatment systems this year, we continue to anticipate growth from our legacy business over last year. We remain very pleased with the new business performance. It is delivering the results we expected and our integration costs are winding down. We remain on track to deliver approximately $100 million in sales this year to expand wood-based activated carbon capacity in 2018 and to fully realize the anticipated synergies from the acquisition in 2019. We remain keenly focused on driving margin dollars and margin percentage improvements and expect to generate gross margin improvements for the second half of the year compared to the first half. We have some major plant maintenance projects that are behind us and expect to benefit from continued strong execution by the new business, manufacturing cost reduction actions that have already been implemented, as well as plant price optimization actions. We are doing a great job of controlling operating cost and combined with receding impacts from acquisition-integration cost, we have set our sights on approaching 15% in operating expenses as a percent of sales for the second half of this year. That’s well below the 16.9% we reported for the first half. These profitability improvements combined with our outlook for sales growth and continued positive trends in end-market demand, reinforces our belief that 2017 will be a better year than 2016. However, considering the change in our expectations for ballast water sales this year and the impact of the second quarter gross margin, we have revised our outlook for 2017 operating income to be in the range of $45 million to $50 million. Keep in mind this is approximately double of 2016s operating income of $24.5 million. With a durable market share in the high-end segments for the end-markets we serve, backed by our premium brand, our customer stickiness, our technical expertise, we are really in great shape for long-term growth. With that we thank you for your attention and we will turn it over for questions.

[Operator Instructions] And your first question comes from the line of Tate Sullivan with Sidoti.

Just to start where you just finished off. Operating margin guidance, so does that imply, I think your previous '17 guidance was about $55 million. So now you are $45 million to $50 million. So is the $5 million decline reflects what's delayed as effectively in the ballast water opportunity? Is that most of it?

Yes. That’s a portion of it as well as our margin performance in the second half, or in the second quarter. Those are probably the two biggest drivers but UB being delayed definitely has a significant impact in the second half of 2017.

Okay. Thank you. And my second one too is on the water market. That was great data, detail you gave on the number of projects and the total value of the orders so far this year. What's the total opportunity set in the water market? I mean what's your share of current water treatment facilities, for instance in, I mean how can you get more leverage with customers? More penetration rather.

Good morning, Tate. This is Jim. It's a good question. So we continue to do really well with these emerging contaminants, specifically 1,2,3-TCP and the PFC opportunities. We are not in a position at this point in time to say what that market opportunity is. I can tell you that that we are out in front of it. We are being successful, both with our equipment sales as well as our carbon sales. Really exciting, it gives us future opportunity for reactivation business. But we expect those opportunities to continue for some time. We are not -- we are just kind of touching the base on the market opportunity at this time.

This is Randy. To add to that, we are having a lot of success with our equipment. And we mentioned product mix this quarter. I mean it's great that we can sell the equipment and to the point Jim made, the more equipment that’s out there that can house carbon, the more carbon that’s available in the future not only for the initial fill but for reactivation that excites us.

Your next question comes from the line of Gerry Sweeney with ROTH Capital.

I apologize, I was on and off the call. I was wondering if you would be able to give us a little bit more, maybe granularity on where you are going to get the margin improvement. I know in years past you definitely had some margin improvement programs in place and then you obviously made the CECA acquisition and there is some opportunity expand, [adoption] [ph] etcetera there. And I guess some margin improvement across the board. But I was wondering if you could give a little bit more detail on historical business as well as maybe CECA and refresh us on those points.

Thanks, Gerry, for the question. We never give up, actually, looking for efficiencies and looking at our not only legacy assets but also the new business assets. Let me give you at least a couple of areas that we are focused on that will be definitely helping the second half of the year. Let's look at plant efficiencies. We expect lower maintenance cost because as I mentioned in our remarks, some major turnarounds are behind us and that should definitely have a positive impact on margins. I also mentioned price optimization. Again, looking around the Calgon Carbon world to see where we have the ability through the services and products to get that. And then also the elements of our mix and that’s tied to it as well so that a couple of times in today's remarks, that mix is regional, it’s part of the equipment versus carbon, outsourced versus our own produced. And finding that right balance is also something we are going to be focused on for the second half of the year which should have positive impact on margins. So these are three areas that definitely are going in the right direction.

And, Gerry, this is Steve. Just to add to that. We have seen a nice improvement in our new business from the first quarter to the second quarter. We expect that improvement to continue and we see a real nice step change coming next year in 2018 as we complete the first phase of our wood-carbon debottlenecking projects. This would have a significant amount of new pounds, perhaps 20% more as well as some cost improvement.

Can you remind us what the pound production is?

On an annual basis it's just over 20 million pounds, perhaps 22 million pounds and as I indicated we might be able to improve that as much as 20% next year.

Got it. And then maybe just on CapEx next year. If I am reading this correctly, full year CapEx this year is $65 million to $70 million. I know, as you were saying some plant efficiency improvements are sort of moving into the rearview mirror. What's the CapEx for next year if available, per say, and I know your budget's not fully finalized but.

This is Bob. Our long-term goal is to be below $40 million starting with next year. And so that’s where right now our heads are at and on a long-term basis I think all those large maintenance and upgrades that we have made in the past are now just behind us.

Got it. And I imagine the key focus is debt repayment within free cash flow -- okay. I appreciate it, thank you.

[Operator Instructions] And our next question comes from the line of Ben Kallo with Robert W. Baird.

Could you just run me through, because I haven't heard these numbers in a while, what your utilization is on your virgin carbon, the non-reac. And then if you could just talk a little bit about how much the third party carbon sales you guys are still doing.

So, Ben, this is Steve. On the virgin carbon, our plants continue to run at 100% except when down for maintenance outages, they are running as well as they ever have. Our reac plants also are running very well but as we have indicated, all of them or at least each region of the world has available capacity. We for competitive reasons don’t offer how much that is. Similarly for outsourced carbon purchases we remain a very significant seller of outsourced carbon both in coconut and in Chinese and we don’t, for competitive reasons, offer how large that is to our total either. Obviously, with mix that we have talked about for a couple of quarters now, we are being successful in selling some of this outsourced carbon and we judge that to be good although there is obviously margin impact.

I guess what I am getting at is, I remember a couple of years ago you [indiscernible] would have price increases -- with a period where there was a couple of them. And where are we in that cycle and what is the -- what's causing it not to be able to happen where you are getting any kind of price increase? Thank you.

Yes. I am not going to go into any detail, Gerry, in terms of the pricing strategies and what we are going to do. I mean there is a lot of carbon out there, there is no question, and we have been saying that for a couple of quarters. And again it's up to us to strategically look at products we produce, products we outsource, optimize for the best margin that we could get for our shareholders and that’s what we will continue to do. And I mentioned price optimization right now. And again, that’s a very thorough study that’s been done in the businesses and the regions and to really extract the value where we believe that we have value.

Our final question comes from the line of Tate Sullivan with Sidoti.

You mentioned more industrial growth and good baseline work and you mentioned, specifically more chemical work. What do you do specifically for the chemical plants?

Hey, Tate. It's Jim again. So what we mentioned first was that our business we saw a pretty big downturn last year and that it stabilized and now has actually turned to the right direction. So we are hoping eventually it gets back to a full recovery which will have a really nice impact to our business. Our products in the chemical space are used within their processes. So to take out containments within a manufacturing process. Sometimes they are used in conjunction with a catalyst to help create a reaction. They are definitely used in the waste water stream and they are also used in some maintenance project. So the chemical customers that we mentioned are a large part of our top tier customers.

No further questions.

Thank you, Crystal. We appreciate that. Just to let everybody know, we would be available this afternoon or maybe this morning for additional follow up calls and you can probably expect to see our 10-Q filed later today. Thank you very much for joining us. Crystal, I will let you close the call.

This concludes today's conference call. You may now disconnect.