CSW Industrials Inc (CSW) 2015 Q3 法說會逐字稿

Thank you for joining the CSW Industrials' fiscal second quarter earnings conference call and webcast. My name is Shay, and I will be your operator for today's call.

(Operator Instructions)

I will now pass the call over to Miss Alison Kane, please go ahead.

Thank you, operator. Good afternoon, everyone, and welcome to the CSW Industrials' fiscal second quarter investor call. Joining me today are Joseph Armes, Chief Executive Officer of CSW Industrials, Kelly Tacke, Chief Financial Officer, and Christopher Mudd, Chief Operating Officer.

If you have not yet received their earnings release, it is available at her website at www.cswindustrials.com. I would also remind you that this call is being recorded. A replay of today's call will be available, and details on how to access the replay are in the earnings release.

During this call, we will be making forward-looking statements. These statements are based on current expectations and assumptions that are subject to various risks and uncertainties.

Actual results could differ materially because of factors discussed in today's earnings release, and the comments made during this call. And the Risk Factors section of our information statement filed as an exhibit to our Form 10 and other filings with the SEC. We do not undertake any duty to update any forward-looking statements.

This call will also include an analysis of adjusted operating income, which is a non-GAAP financial measure of performance. This non-GAAP measure should be used as a supplement to and not a substitute for net income computed in accordance with GAAP. For a more complete discussion of adjusted operating income, please see our earnings release.

I'll now turn the call over to Joe Armes, Chairman and Chief Executive Officer. Joe?

Thank you, Alison. Good afternoon, everyone, and thank you for joining us on the call today.

On September 30, 2015, we completed the spinoff from Capital Southwest Corporation. And I'm pleased to lead CSW Industrials as an independent publicly traded Company.

We believe the benefits of this reorganization present a compelling investment case. We have unlocked shareholder value, and going forward we expect to deliver earnings growth and drive long-term shareholder returns.

To that point, I am pleased to announce that in our first reported quarter as a public company, we grew revenue and adjusted EPS by 23% and 6% respectively. As an integrated Company, we are able to leverage a broad portfolio of leading industrial brands with a proven track record and a diversified set of end markets.

The consummation of the spinoff, a process that began over 12 months ago, marks an important milestone. And we are pleased to be underway in achieving our near-term objectives. Which include the integration of our business units, and the execution of our growth strategy, both through executions and organically.

Beginning with our acquisition strategy, we have already been active through the completion of two recent transactions. In the fiscal first quarter and prior to the spinoff, we acquired the assets of Strathmore Products, as previously disclosed, for $68.8 million. And based on 2014 results, Strathmore would have added more than $60 million in annual sales, with operating income of just over $8 million.

Strategically, it creates a meaningful market presence for us in industrial coatings, and provides a solid platform from to grow through end market and geographic expansion. I am pleased to announce that after our first six months of ownership, the integration of Strathmore remains on track.

We also completed our first strategic acquisition as an independent company on October 1. This was of Deacon Industries. Deacon is a leading manufacturer of high-temperature sealants and injectable packings, and serves a variety of complementary end-use markets for us.

This product line acquisition will be consolidated into our coatings, sealants and adhesives segment. And we believe the business is positioned to benefit organically from our broad distribution network.

Moving onto integration. We have made good progress to date in combining six individual businesses into an integrated company under our three operating segments. This process is a critical component to our overall strategy. And touches every part of our business including operations, sales, finance, and other shared services.

While this process is well underway, we are still in the early stages, and expected to be an evolution over time. Highlighted by continuous improvement, as we work to identify the most effective ways to leverage our assets. In addition, our finance team is working to optimize and consolidate our reporting practices to transition the way we analyze our business from individual operations into a diversified industrial growth company.

This reorganization represents a significant transformation across the Company, and will take some time. But we expect to be in a position to deliver an added level of transparency and enhanced disclosures to shareholders over the next few quarters. Not the least of which is the adoption of a formal guidance policy, which we expect to roll out at a later time.

We have also taken some initial steps to enhance our capital management, which is a key rationale for our reorganization. One of these initiatives is an integrated corporate credit facility. And on November 3, we received a commitment from our bankers for a $200 million revolving credit facility.

We expect to close this financing by the end of the calendar year, which will substantially refinance all outstanding debt. And provide significant added liquidity to fund the execution of our acquisition strategy.

Turning to organic trends. As you will note, we report our results by our business segments which are grouped by products. But we also analyze and manage our business according to the end markets we serve, to assess opportunities and to monitor our performance.

In the second quarter, HVAC, plumbing, and architecturally specified building products continued to drive organic growth. Which taken together, represent a little over half of our total revenue.

Rail, which represents around 15% of our mix, also continues to deliver positive growth. This was partially offset by lower volume in energy, mining, and industrial related products, which represent just under 30% of our revenue. As commodity price pressure and slower industrial activity negatively affected demand.

Overall, we are pleased but not satisfied with the performance in our second quarter, and we are committed to building a leading diversified industrial growth company. Now with that, I will turn over to Kelly for a closer look at our financials.

Thank you, Joe.

Second-quarter 2016 revenue of $83.7 million, increased 23% as compared to the second quarter last year. As the result of higher volumes sold, and the addition of Strathmore Products. Higher sales volumes, primarily in industrial and rail products, were partially offset by decreased sales in energy and mining industries.

Consolidated gross profit increased to $40.8 million, an increase of 23.1% as compared to the second quarter last year. Reported results included a $2.7 million pension curtailment gain, and on an adjusted basis, increased 15.1% to $38.1 million. Adjusted gross margin declined 310 basis points to 45.6% from the inclusion of lower margin Strathmore Products.

Operating expenses for the quarter declined $1.4 million or 6.4% to $20.1 million compared to the prior period. On an adjusted basis, operating expenses were $24.1 million or 28.8% of sales, compared to $21.4 million or 31.5% of sales in the prior year. Looking forward, we expect to incur incremental recurring quarterly overhead expenses of $1.5 million, reflecting standalone public company costs.

Consolidated operating income was $20.8 million or 24.8% of revenue. Which included a one-time gain on freezing the defined-benefit pension plan, acquisition costs related to Strathmore, and certain organizational start up costs which we have detailed in our press release. Excluding these items, operating income was $14.1 million, which was up 19.9% from $11.7 million in the prior period.

Adjusted operating margin contracted 50 basis points to 16.8%, which was expected due to the inclusion of the lower margin Strathmore Products.

Net income for the quarter of 2016 was $13 million or $0.83 per diluted share. Excluding one-time items, adjusted net income was $8.6 million or $0.55 per diluted share compared to $8.2 million or $0.52 per diluted share in the prior period.

Now turning to our business segments. Industrial products' second-quarter revenue was $36.2 million a 21% increase over the prior period of $29.9 million. This increase in sales volume resulted from strong customer demand of existing products, particularly in the HVAC, and architecturally specified building products.

Industrial products' segment operating income, adjusted for one-time items, was $8.5 million or 23.5% of sales compared to $4.7 million or 15.6% of sales in the prior period. Higher margins during the period were mostly related to operating leverage on higher sales.

In our coatings, sealants and adhesives segments, second-quarter revenue was $28 million an increase of 106.6% over the prior period of $13.5 million. Essentially all of this increase was attributable to acquisitions.

Coatings, sealants and adhesives segment operating income, adjusted for one-time items, was $3.9 million or 14.1% of sales compared to $2.9 million or 21.7% of sales in the prior period.

In our specialty chemicals segment, revenue was $19.8 million, a decrease of 18.7% from the prior year of $24.3 million. Lower revenues stemmed from lower volume in energy and mining end markets, as commodity price pressure decreased customer production from volume. This decline was partially offset by an increase in rail sales volumes.

Specialty chemicals segment operating income, adjusted for one-time items, was $1.5 million or 7.8% of sales compared to 4.2% or 17.2% of sales in the prior year. Primarily reflecting lower volume and operating leverage.

Turning to our balance sheet and cash flow. As of September 30, 2015, we had $53.9 million in cash, and had total long-term debt outstanding of $76.7 million. Which resulted in a net debt position of $22.8 million.

Year-to-date cash flows from operations were $21.6 million an 8.8% increase compared to the prior year of $19.8 million.

I will now turn the call over to Chris for an operations update. Chris?

Thanks, Kelly.

As Joe noted earlier, a little over a month and half post spend, and our integration efforts are already underway and we are making good progress across our three business segments. Joe articulated this process as an evolution, which I think is appropriate, as it helps frame the philosophy and work ethic across our organization of continuous improvement.

It's important realize that prior to the spinoff from Capital Southwest, all of these businesses operated independently of each other with the only link being a common owner. That presents a wide range of opportunities and challenges as we consolidate into three discrete operating segments, and look to leverage our Corporate-wide capabilities into a single vision to drive shareholder value through a collective effort.

So far, we have identified several areas to focus our early efforts. Which include the implementation of operational excellence programs at all of our operating units, selective facility consolidations, and a refreshed performance management and compensation strategy.

Beginning with our operational excellence efforts, we have initiated an information sharing process between business leaders to identify best practices and breakdown organizational silos. Recently, we organized a commercial and technology summit with business leaders and subject matter experts across segments. Which identified significant opportunities for cross-selling of products between businesses and technology sharing.

This initial meeting lead to more than 30 action items, including ten high-priority items, commencement of weekly progress calls and information sharing sessions. We've scheduled similar meanings for next month, which will include manufacturing, environmental health and safety summit as well, as a purchasing group summit. It's very exciting and gratifying to build this internal network which leverages our capabilities and expertise across the CSWI organization.

These principles go beyond operational benefits to reduce costs. As a unique attribute of our reorganization is that each of our portfolio companies have a discrete set of relationships across multiple industries. Therefore, we have a tremendous opportunity to introduce our technology and capabilities to new industries, through lead sharing across businesses and locations.

Importantly, while we expect these efforts will produce results in the short term for existing portfolio companies, it also serves as a roadmap. As we execute our acquisition strategy, and we already seeing the benefits in the integration of Strathmore, Deacon and others.

Next, in certain circumstances, we have an opportunity to optimize our footprint and reduce operating costs. Our first major project in this regard is the consolidation of Jet Loop's Houston production into our state-of-the-art Whitmore facility in Rockwall, Texas. We recently brought our first new production vessels online at the Rockwell location, and we are currently accelerating plans to complete the project ahead of schedule.

We have also relocated key staff members to Rockwall, to ensure annuity and continuous improvement. In total, we expect this initiative to produce $4 million in annual cost savings once completed.

In another example of footprint optimization, we have recently signed a lease with the intention to exit an expensive and inefficient third-party coatings manufacturing agreement. We expect to move production into a new and efficient facility in the greater Houston area during calendar year 2016.

Lastly, we have redesigned our performance management and compensation plans to reflect an integrated business, attract new talent, and reward performance across the organization. First, we have adjusted our annual performance bonus and employee stock ownership programs to consider individual, business unit and consolidated performance measures.

We also believe the reorganization creates enhanced career development opportunities for our employees. And necessitates an infrastructure to develop and retain talent across the organization. Therefore, we have launched a development program for emerging leaders, and have implemented corporate-wide medical, dental and 401K plans, which are competitive in our industry.

And now, I will turn the call back over to Joe for closing remarks.

Thank you Chris. Let me take this opportunity to thank you for your interest in CSW Industrials. And to also thank all of our colleagues here at CSW Industrials for your partnership, as we continue to serve our customers and steward well the capital entrusted to us by our shareholders.

Operator, we are now ready to take questions.

(Operator Instructions)

Jon Tanwanteng from CJS Securities.

Good afternoon. Thank you for taking my questions.

You bet, Jon. How are you?

I'm doing well. First off, from an end market perspective, what was surprising to you in the quarter? And maybe following that, what looks sustainable, and maybe what did trends look like heading into Q3?

Sure. As we look at the end markets, obviously energy is by far the largest concern. The energy markets have been very, very difficult and continue to be. So we do not foresee any improvement in that in the near term. Other end markets are slow, such as industrial. A fair amount of our industrial end markets are related indirectly or directly to energy, and so some of that is a result of the energy markets as well.

Rail has been relatively steady. Plumbing has been strong, HVAC has been very strong, and our architecturally specified building products end markets have been very strong. So I don't see any significant changes in those end markets in the near term, Jon.

Okay, thank you. And just in terms of realizing the synergies, you mentioned a couple facility integrations and a new lease. How far along are you in those plans? When do we see the full effects of that hitting the P&L?

Sure. Our best estimate is that you would see the full savings from the Whitmore Jet-Lube integration during calendar year 2017. And the leased facility in Houston for the coatings business, the coatings segment, will come online during 2016. So that might be a little bit earlier.

Okay. And how does that match up to the incremental costs of being public? I think I heard you say an additional $1.5 million. Is that just in Q4, or is that an annual number? And how much further do you have to go beyond that?

That is an annual number for -- I'm sorry, a quarterly number, $1.5 million or $6 million per year. That includes all of the auditing, legal, Sarbanes-Oxley compliance, and senior-level management here. And so $6 million a year, $1.5 million per quarter. Clearly, the savings from the Jet-Lube Whitmore integration will go a long way toward covering those incremental expenses.

Got you. And is that $1.5 million incremental on a quarterly rate to what you just reported, or is that -- is there some of that already baked in?

That is incremental. Because the quarter ended September 30, and the spin was effective September 30. So there were no corporate overhead costs, public company costs, in that quarter.

Great, that is helpful. Thank you. Can you talk a little bit about Deacon? What does the revenue and the profitability look like, what did you pay? Any kind of color would be helpful on that.

We are going to be releasing an investor presentation tomorrow with some details around that. I will let Chris address the qualitative, the quantitative will be in the investor presentation tomorrow, Jon.

Sure. The purchase price was $12 million. And the -- which represents a multiple of about 7 times last 12 month EBITDA, and it should add about $4 million in revenue. So those were some of the numbers around that that will be included in the presentation tomorrow.

Okay, great. And just from a higher-level perspective, is Deacon representative of the types of businesses and assets that you're going to try to look at from an M&A perspective? Maybe just a little bit more about the size of what is in your pipeline. Is there anything exciting there? And your ability to finance it as well.

Sure. Certainly, we have to be careful about forward-looking statements. I would say that Deacon is a very good representation of the add-on acquisitions that we would like to do. These are smaller product line extensions that fit very, very well within our business. They really give us the opportunity to leverage our distribution channels, and Deacon is a prime example of that type of acquisition. Larger acquisitions where we actually acquire people and facilities, which we did not acquire at Deacon, require more integration work, and we will look at those as well.

Strathmore is a great example of that type of acquisition. But Deacon is a wonderful example of product line acquisitions, lower risk opportunities for us, an attractive entry multiple, and again, really leverages our distribution channels very, very well. We think that the Deacon products can be sold into several of our end markets, and so we are excited about that.

With respect to financing, one of the things that we mentioned in our comments is that we have received a commitment letter from our banks for a $200 million revolving line of credit. And the primary purpose of that financing would be to refinance the existing debt that we have in place, and then to provide liquidity to fund our acquisition strategy. So we believe with that in place, we would have plenty of dry powder to pursue our acquisition strategy as we have articulated.

Okay, great. And just one more housekeeping question. What are the one-times expenses we should be looking for in the next quarter? Just with the closing of Deacon, and I don't know if there's anything leaking over from closing the standalone company.

I would give you range. I think it's the best way to look at that possibly $0.5 million, $0.5 million to $700,000, maybe even $800,000.

Great, that's very helpful. Thank you very much.

Great, Jon. Thank you.

(Operator Instructions)

John Hudson from Greywolf Capital.

Hello, everybody. Do you happen to have the revenue and EBITDA number for last year's third fiscal quarter? Which would be the comp to the upcoming quarter?

We don't, and I realize that creates a bit of a problem. But we are going to be providing that disclosure on a quarterly basis as we go. We don't really have those numbers today, and so we are going to disclose those next quarter. And then by virtue of the fact that you get the third quarter after the end of the December 31, then you'll be able to subtract and do the math to get the [third] quarter as well. So I apologize we don't have that today, but we will have that next quarter.

Okay. And then just to follow-up on some of Chris's comments, I think he mentioned that the Rockwall project was accelerating, and might be completed ahead of schedule. Does that tie into -- I think, Joe, you said you expected savings in calendar year 2017. That's still the case? Even with accelerating?

Yes, Chris can speak to this little more if he'd like. But we have encouraged and suggested that that move along in an expedited fashion. So we are working diligently to find ways to move that ahead more quickly.

At this point, I don't think we can commit to the savings being any sooner than calendar year 2017, but you should know that we are very highly focused on moving that integration ahead. It's a meaningful savings to us, and we want to get that done as soon as possible.

That is right. We feel like this is a great opportunity at this time, because there's, as Joe mentioned, we have had a slowdown in demand for some of the energy and related products. Why not take advantage of that opportunity to go ahead and accelerate the transition. This way we can make sure that we have excellent quality products being produced in Rockwall, take good care of the customers, and go ahead and get this movement moving a little bit quicker. And so we are working on that, and should be a few months ahead of our previous plans, get the capital invested and get the product transitioned into Rockwall sooner.

Okay. And I think you mentioned you had just signed this lease in Houston, and it sounded like you were bringing some manufacturing back in house. Is that what the purpose of that is?

Yes, that is correct. When we acquired Strathmore, there was a very expensive third-party contract manufacturing arrangement in place. And we acquired the equipment, but not the facility itself. And so by leasing a facility, moving our equipment into the new leased facility, we are going to have some meaningful savings there. And without a significant capital expenditure.

Okay. Any ballpark on what significant means?

The CapEx is going to be minimal via savings. I don't -- it depends on a number of factors, but I don't -- no I don't think we have that to disclose today.

It will be additional throughput, so there certainly will be benefits related to having our own facility versus relying on third-party contract manufacturing. But I don't think we've quantified the dollar impact of it. But it certainly will be a state-of-the-art new facility that will be a good way to serve our customers.

Okay. And I think in the MD&A, you had mentioned several times that the Strathmore margins were a drag on the overall margins. So is this part of a plan or strategy to get those margins up?

Absolutely, yes. We have noted several initiatives there. One is procurement, one is this contract manufacturing arrangement that we are going to move out of, and the third one is really rationalization of the products and where they are produced. At this time, it seems that several different products are made in each plant and we think we can streamline that as well.

Okay. Great, that is all I had. Thank you.

Thank you.

Thank you. I'll now turn the call back over to management for any additional or closing remarks.

Again, thank you very much. Our very first quarterly conference call. We look forward to more, and increased disclosure and transparency as we go forward. But we are very, very grateful for your interest, and thanks for being on the call today.

Thank you. This does conclude today's conference and webcast. You may disconnect your lines.