http://www.morningstar.com/earnings/31442443-zep-inc-zep-q4-2011.aspx

Zep Inc ZEP
Q4 2011 Earnings Call Transcript

Transcript Call Date 10/13/2011

Free cash flow was an even stronger metric for the quarter, increasing 28% from last year to over $21 million, which is also a record. I am very pleased with the performance and discipline of the team in managing an already strong balance sheet of the business.

On the other hand, while we are pleased with these record sales and cash flow results, fourth quarter adjusted earnings per share came in at $0.24 or 27% below last year. The year-over-year decline in quarterly profits was primarily the result of raw material inflation and higher input costs, with gross profit degradation contributing $0.12 per share to this decline.

We are taking actions to address the issues impacting gross profit margins. However, we expect that the imbalance between pricing, relative to raw material inflation, will persist in the immediate future. As a result of these factors, adjusted EBITDA in the quarter declined 19% with adjusted EBITDA margin falling 240 basis points to 7.3%.

Later in the call, Mark will provide a detailed understanding of factors impacting our gross margin and what we might expect for the foreseeable future. I'll simply say here that the gross margin and organic sales issues that we face are clear. Incremental price increases to save off rising commodity costs are proving difficult to achieve against such a weak economic backdrop.

This is compounded by the fact that our customers, particularly in the sales and service channel, are typically small business operators who are themselves disproportionally struggling in this challenging economic environment. This combination of high unemployment and raw material inflation is unusual, and continues to impact gross margin, particularly given that this channel has endured several rounds of price increases over the past two years. Over time, we must bring the material margin relationship back into line but I would caution that we believe it will take longer to do so in market conditions such as we are currently experiencing.

Now let me give you a sense of top line performance on both in in-market basis, as well as a channel specific basis. As you can see from this slide, which I believe is Slide 7, we are focused on seven strategic growth vehicles which represent greater than 40% of our total sales today. Overall, we've not seen much change in our end markets since we last spoke to you at the end of the third quarter, and we believe that the rate of growth in most of these markets remains moderate. That said we were very pleased with the growth from our automotive and food initiatives, although they were more than offset by sales declines in other end markets such as jan-san, government and vehicle wash. Our automotive initiative is demonstrating strong growth in all channels and was up double digits in the quarter. Our food initiative continues to demonstrate solid results increasing mid-single digits in the quarter. We were pleased with these initiatives and their contribution to our record sales increase.

Government, janitorial, and other end markets on the other hand remained under pressure due to economic constraints, such as lower tax revenues and the continued high level of unemployment. That said the cumulative impact of our various initiatives has resulted in an overall revenue growth in excess of the market. Sales in jan-san declined mid-single digits as a result of the various integration initiatives completed during the quarter, although we did see a sequential improvement relative to the third quarter. With the Waterbury integration complete now, the jan-san initiative has the capability to deliver one order, one shipment, and one invoice for our customers. This was a tremendous accomplishment by our associates and one which I would expect will contribute to future growth.

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