CSW Industrials Inc (CSW) 2016 Q4 法說會逐字稿

Greetings and welcome to CSW Industrials, Inc. fourth-quarter 2016 earnings call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Joseph Armes, Chief Executive Officer for CSW Industrials. Thank you, Mr. Armes, you may begin.

Thank you, operator. Good morning, everyone, and welcome to CSW Industrials' fiscal fourth-quarter investor call. Joining me today are: Joseph Armes, Chief Executive Officer of CSW Industrials; Gregg Branning, Chief Financial Officer; and Christopher Mudd, Chief Operating Officer.

If you have not received the earnings release it is available on our website at www.CSWIndustrials.com. This call is being recorded. A replay of today's call will be available. 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 materially differ because of factors discussed in today's earnings release and the comments made during this call and in our Form 10-K 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 see our earnings' release.

With that, I would now like to turn our call over to our Chairman and Chief Executive Officer, Joe Armes.

Thank you, Tom. Good morning, everyone. Thank you for joining us on our call today. First, I'd like to remind everyone that we're on a fiscal year ending March 31. So, the results released yesterday are for the fourth-fiscal quarter of the year that ended March 31, 2016.

We were pleased to see an improvement in our operating results following the lower seasonal volumes that we reported in the third quarter. Quarterly revenue of $76.3 million and adjusted earnings per share of $0.35 were both right in line with our expectations and reflected higher seasonal demand in our HVAC end-market, continued strength in demand for our architecturally specified building products, and some signs of stabilization in energy markets.

During the quarter we continued to make incremental progress toward our long-term strategy to build our Company into a leading diversified industrial supplier in the markets we serve. The quarter was highlighted by our focus on integration activities.

And I'm pleased to report we have identified an additional $0.5 million in annual savings as we made the decision to consolidate the specialty chemicals manufacturing at Jet-Lube Canada into our Whitmore manufacturing facility. These additional savings bring our total identified annual cost savings to $5.5 million, which we expect to fully realize by the end of FY17. This is in addition to the identified procurement savings of $2 million that we had previously disclosed.

While the fourth quarter was quiet on the acquisition front, we worked diligently to execute our integration plans for both Deacon and AC Leak Freeze. And I'm pleased to report that both of these acquisitions are performing well and were positive contributors to our fourth-quarter results.

Regarding Strathmore, volumes remain challenged due to its exposure to energy markets, but we have identified a clear path to improved profitability through both cost reduction initiatives and new-growth opportunities, which Chris will detail for you in just a moment.

Turning to our end-markets for FY16, and beginning with HVAC and plumbing, which combined is approximately 37% of our mix, strong year-over-year growth continued as commercial and residential construction activity remains favorable. And the quarter benefited from a sequential improvement from the third quarter as seasonal volume recovered following the winter season. Volume in our architecturally specified building products category, which accounts for roughly 14% of our mix, also provided a strong contribution to our organic growth as both Smoke Guard and Balco posted record results in FY16.

In our rail business, which is approximately 16% of our mix, we saw continued organic growth in consumable lubricants during the quarter, although coatings volume at Strathmore remained under pressure, as I mentioned.

Turning to energy, mining and industrial end-markets, which collectively represent approximately 30% of our revenue mix, volume remained under pressure, as anticipated, as lower industrial activity and lower commodity prices continued to impact our business. We anticipate the depressed volume in energy markets will persist for some time, although we were pleased to see some stabilization in commodity pricing during the quarter, which should stabilize volume in the coming quarters.

At a consolidated level, and similar to the third quarter, the majority of our business is growing at a healthy organic rate but not enough to offset the magnitude of the decline in energy-related volume. As a result, our consolidated organic revenue declined by 1.6% in the fourth quarter and 0.3% for the full year, reflecting a decline in energy-related sales of approximately 40% for the full year. Excluding energy, the balance of our business grew organically by approximately 6% for the full year.

Moving to our financial results in the period, during our discussion I will be referring to our adjusted results that exclude one-time items during the quarter and the full year, unless otherwise noted, as GAAP results. Non-GAAP results exclude acquisition related costs, start-up costs following our spinoff transaction from Capital Southwest, and the large favorable pension adjustment realized in the fiscal second quarter. For a full reconciliation of GAAP to non-GAAP results, please refer to our earnings press release on our website.

Fourth-quarter FY16 revenue increased 19% to $76.3 million and full-year FY16 revenue increased 22.2% to $319.8 million. Higher revenue in both the quarter and the full year were the result of recent acquisitions including Strathmore, Deacon, and AC Leak Freeze, and higher organic sales in HVAC, plumbing, and architecturally specified building products. These benefits were partially offset by decreased sales in energy, mining, and industrial end-markets.

Fourth-quarter gross profit increased to $34.4 million or 35.1% of sales as compared to $30.8 million or 48% of sales in the fourth quarter last year. Lower gross margin compared to the prior year was anticipated from the inclusion of the Strathmore acquisition, which is lower margin business compared to our corporate average. For the full year, gross profit was $147.9 million or 46.2% of sales, compared to the prior-year level of $126.4 million or 48.3% of sales.

Operating expense for the fourth quarter of FY16 increased to $27.6 million or 36.2% of sales compared to $22.3 million or 34.9% of sales in the prior year due to increased operating expenses incurred in connection with the companies acquired in FY16. For the full year, operating expenses were $100.4 million or 31.4% of sales compared to $82.4 million or 31.5% of sales in the prior year.

GAAP net income for the fourth quarter of FY16 was $1.9 million or $0.12 per diluted share compared to $5.3 million or $0.34 per diluted share in the prior year. However, excluding one-time items and normalizing the effective tax rate, adjusted net income was $5.6 million or $0.35 per diluted share.

Full-year FY16 GAAP net income was $25.5 million or $1.62 per diluted share compared to $29.7 million or $1.90 per diluted share in the prior year. Excluding one-time items and normalizing the effective tax rate, adjusted net income was $27 million or $1.72 per diluted share.

Turning to our balance sheet and cash flow, as of March 31, 2016, we held $39.3 million in cash and equivalents and had long-term debt outstanding of $89.7 million, which resulted in a net debt position of $50.4 million. At year end, our trailing net debt-to-EBITDA ratio was 0.8 times. Importantly, free cash flow for the 12 months ended March 31, 2016 increased 13.7% to $30.5 million compared to $26.8 million in the prior-year period.

As we look to the year ahead, we're well-positioned within the markets we serve and anticipate our organic growth rate in FY16 will exceed the end-market growth in each of our segments. By end-market, our current view suggests strength in commercial and residential construction will continue to positively contribute to our organic rates and drive the majority of our organic growth for the year.

In our rail business we expect to see flat sales in 2017 as higher demand in our specialty rail lubricants is offset by lower railcar coatings volume. And in energy, mining and industrial, while we are not forecasting a recovery in the coming year, we do expect volumes to stabilize in 2017 and the pressure on year-over-year comparables to abate as the year progresses.

Looking ahead, regarding our profitability, given the significant integration efforts across our platform and the potential savings we have outlined, we expect earnings growth to outpace sales growth nicely in 2017.

In a moment, Chris will provide a closer look at our segments. But, first, I would like to take a minute and introduce our new Chief Financial Officer, Gregg Branning. Gregg is joining us here on the call today. He has been with us for a month in a consulting capacity getting up to speed before officially taking the helm as our Chief Financial Officer today.

Gregg brings strong financial leadership to the CSW Industrials' team, having previously served as Senior Vice President and Chief Financial Officer at Myers Industries, where he helped lead the transformation of Myers. Gregg has extensive experience in accounting, debt markets, strategy, investor relations and corporate development.

In addition to Gregg's experience at Myers, he spent nine years at Danaher Corporation in various CFO roles, as well as President of one of Danaher's subsidiaries. Gregg also spent 13 years with United Technologies' Hamilton Sunstrand subsidiary in financial roles in increasing responsibility, and seven years in public accounting including time with Ernst & Young as an audit manager. We are very pleased to have Gregg join our team and to bring his skills and experience, which we know will help drive our strategy going forward.

Now I'd like to turn the call over to Gregg for a brief introduction and then to Chris for a look at the operational details for the quarter. Gregg.

Thanks, Joe. As Joe mentioned, I have had an opportunity in the past month to dig in and begin to develop a good understanding of CSW Industrials. From this initial look I am looking forward to help build this Company from the groundwork already laid by the team.

I was attracted to CSWI because of its best-in-class products and the opportunity to expand on the depth and breadth of the Company as a combined entity. I view the unique business combination that resulted from the spin as a truly compelling long-term growth opportunity for all stakeholders.

In the coming months I'm excited to help build upon the success of the team, although I am mindful of the hard work still in front of us. From a financial perspective, we will be working to continue to enhance our reporting structure and systems which will enable us to leverage stronger operating analytics internally and provide enhanced visibility through improved disclosures to the investment community. I look forward to meeting all of our key stakeholders in the next few months and sharing our progress next quarter.

And now I will turn the call over to Chris.

Thanks, Gregg. During our segment-level discussion I will be referring to our adjusted segment-level results which exclude one-time acquisition costs, start-up costs following our spin from Capital Southwest, and excludes the pension gain incurred in the second quarter.

First, industrial products. Industrial products' fourth-quarter revenue was $33.9 million, an increase of 15.6% compared to the prior year of $29.4 million. This increase in sales volumes resulted from strong customer demand for our HVAC products and also the benefit of seasonal volume as we enter the air conditioning season in North America.

This segment also benefited from strength in our architecturally specified building products which delivered record sales and profit contributions. And this includes both Balco and Smoke Guard. At Balco, higher volume has been attributable to their successful entrance into international markets, while Smoke Guard has seen tremendous success in new product introductions, particularly in the large screen curtains.

For the full year, segment revenue increased 17% to $138.6 million. Industrial products operating income, adjusted for one-time items in the fourth quarter, was $6.3 million or 18.5% of sales compared to $5.3 million or 17.9% of sales in the prior period. The increase in income relative to the prior year was related to higher sales during the period and a favorable sales mix. For the full year, operating income increased 41.5% to $27.9 million.

Next, coatings, sealings and adhesives fiscal fourth-quarter 2016 revenue was $25.3 million, which was nearly double the prior-year period of $13.8 million, and this is due to the acquisition of Strathmore. For the full year, revenue increased 103.4% to $106 million.

Fiscal fourth-quarter segment-level operating income was $257,000 or 1% of sales, compared to $2.4 million or 17.4% of sales in the prior year. Operating income was pressured during the period from lower overall volume, particularly in energy-related end-markets, and the lag effect of our integration efforts taking effect.

As we discussed last quarter, we have identified a clear path to stronger coatings segment profitability, and this includes: first, bringing inefficient third-party manufacturing in-house; also procurement savings; third, reshaping our product portfolio to identify portions of the business that are not profitable and adjusting pricing as needed; and, finally, diversifying our end-markets to smooth the cycle across a broader set of exposures. While much of this initiative is a longer lead time activity, we are pleased to announce that we did win our first meaningful above-ground storage tank contract during the quarter.

Coating, sealings and adhesives previously identified approximately $1 million of potential procurement savings, and we're on track to achieve that. However, with the addition of the in-house manufacturing initiative, we now see the potential cost savings of greater than $1.5 million in the aggregate. The majority of these savings will be volume dependent but we expect the savings to phase in during the first quarter of FY17, and reach full run rate by the end of the current fiscal year.

Finally, turning to specialty chemicals, fourth-quarter revenue decreased 15.8% to $16.9 million from $20.1 million in the prior year. As we have discussed, this is our most energy sensitive segment as more than three-fourths of Jet-Lube's business is in this segment. That being said, we're beginning to see some stabilization in global energy prices although we are not expecting to see a strong recovery in FY17. For the full year, segment revenue decreased 16.5% to $74.9 million.

Fiscal fourth-quarter segment-level operating income was $3.6 million in specialty chemicals or 21.1% of sales. That's compared to $934,000 or 4.6% of sales in the prior year. This improvement was driven by some anomalies in both 2016 and 2015, as well as higher margins from AC Leak Freeze. Absent these anomalies, margins in fourth-quarter 2016 were up approximately 300 basis points over the prior-year quarter.

As Joe noted earlier, we have been active in our integration efforts since becoming a standalone Company, and we're continuing to make great progress executing our plan to optimize our footprint, reduce operating costs, and expand our product reach across a wider set of end-markets. We remain on track with our Jet-Lube facility consolidation, and we've identified potential savings well in excess of our original estimates, with total project savings of approximately $5.5 million annually, compared to our initial projection of $4 million. In total, our integration activities have identified $7.5 million in potential cost savings, which includes the $5.5 million from Jet-Lube consolidation, and $2 million from procurement across the portfolio.

Much of these results have stemmed from our operational summits. These are Company-wide meetings with business leaders in their respective disciplines to identify best practices and build a corporate-wide infrastructure in areas like purchasing, sales, marketing, environmental and safety. We continued these in the fourth quarter and developed a commercial excellence team. This team has two main focus areas including synergy and cross-sell opportunities and marketing.

The first area, synergy and cross selling, involves identifying areas to train team members on selling products across industries, modified compensation structures to reward success, and utilizing analytics to maximize the benefit of our distributor networks.

The marketing side of this team is a longer lead time focus and includes utilizing a central platform to market products and also branding. Specifically, our first focus area is website optimization to have a coordinated and linked web-based marketing program.

And, lastly, in the fourth quarter we created our Leadership Development Initiative. This program breaks team members into early- and mid-career groups and identifies a path to achieving career goals, provides training towards these objectives, and gives employees the ability to work on a cross-section of products to support the business. We view this as an important development for succession planning and corporate development and I'm personally very excited to work with our talented team on these objectives.

So with that, I'd like to turn the call back over to Joe.

Thank you, Chris. We are pleased but not satisfied with the progress we've made in FY16, during which we grew free cash flow meaningfully and we will endeavor to do so again in FY17. We continue to believe that our broadly diversified product portfolio and end-markets provide a stable platform, and combined with our strong balance sheet and the dry powder it provides equips us more than adequately to execute to our long-term growth strategy.

Finally, I want to acknowledge my colleagues here at CSW Industrials and thank them for their diligence, professionalism in serving our customers every day. We take seriously our responsibilities as a Management Team. We are resolute in our commitment to steward well the capital that you, our shareholders, have entrusted to us.

Thank you for your time today and for your interest in CSW Industrials. Operator, we're now ready to take questions.

(Operator Instructions)

Our first question comes from the line of Jon Tanwanteng with CJS Securities. Please proceed with your question.

Good morning. Thanks for taking my questions. Can we just go back to the energy, mining and industrial commentary? Do you actually expect to see organic growth in that segment or end market in FY17?

No, we don't.

Okay. Got it. And maybe help us to understand when the synergies and the cost reductions that you have laid out begin to completely offset the corporate infrastructure that you have put into place as a public company.

Hey, Jon, this is Chris.

The two different areas that we talked about, the Jet-Lube Whitmore integration, as you might remember, the Jet-Lube Houston facility lease goes through the end of this current fiscal year. So we're starting to see some of the synergy savings already.

We've already completed the transfer all manufacturing to Whitmore, and so we ceased manufacturing at the Houston facility. We've also ceased manufacturing in Canada. So, I would say through this fiscal year we will see with each quarter savings starting to materialize.

The other area was on the procurement cost savings where we've identified a total of $2 million. We've identified about half of the Strathmore savings and have implemented that and the rest of it we're just getting into. By the end of this current fiscal year we expect to be at that $5.5 million and the $2 million of procurement savings by the end of this fiscal year, but it will be ramping up during the year.

Okay. Is it more of a straight line or do you think there's going to be some kind of step function when you finish that lease?

It's going to be a little bit choppy. Obviously in the case of things like the lease arrangement that we have on the facility in Houston, that doesn't go away until March 31 of 2017. But overall, it's going to be a little bit choppy as we go through it.

Okay. Thanks.

This is Gregg. Maybe some clarification.

What we'll see is we'll be at that run rate savings as we exit Q4. So I don't think we'll see the full savings in the year. We'll see quite a bit of it. But the key is that we'll be in a run rate position by Q4.

Okay. Great. Thanks. And, Gregg, by the way, welcome aboard, number one.

Number two, could you help us understand what went into the unusual tax rate in the quarter? And how should we think about one-off items and adjustments in the future quarters?

Sure. Some of the discrete items that we had in the quarter, we had approximately $1.3 million related to some state tax matters associated with the spin. There was also approximately $800,000 of transaction costs that we had related to the spin. And then $900,000 of acquisition-related costs that all affected our tax rate to drive the effective rate as high as it was from a GAAP perspective.

We would expect that our effective tax rate would come down to a more normalized level in 2017, absent any new acquisitions. So I think this is more of an anomaly in the quarter and the year for FY16 as a result of the spin and some of the other transactions that took place.

You asked me another question about adjusted earnings and I failed to remember exactly how you asked that.

Just what other adjustments should we expect in future quarters, whether it's integrations or anything else like that?

Certainly we're not aware of any at this point. We have not planned on any. But if they come up, we'll certainly make you aware of them and disclose them as such. Most earnings type items are things that you don't necessarily anticipate. That being said, the only thing I will say is that there will be some impact to our Q1 results as a result of the transition.

Okay. Great. Thanks. And, finally, just any update on the prospects or the landscape for M&A in the near future? Are you expecting to pick up the pace at all?

Absolutely, Jon. We continue to be highly focused on accretive, bolt-on acquisitions that help us to leverage our distribution channels effectively. And we've had great success with the Leak Freeze and the Deacons and others of doing that.

I would say that the market is really still very frothy. We've been involved in a process very recently, we're all still a little stung by it, that great business, right in the middle of our fairway that we were actively pursuing and had several opportunities to raise our of bid. We raised our bid a time or two and ultimately got to a point where we just had to say no and that company went to another buyer.

So, we're going to maintain our discipline. And we're going to continue to focus on, again, accretive bolt-on acquisitions. But I would say that the market's really frothy and really expensive right now, and discipline, we hope and we believe, will be rewarded in the long run.

I think it will be. Thanks again, guys. We look forward to having you guys at our conference in July.

There are no other questions in queue. I'd like to turn the call back over to management for closing comments.

Great. Once again, we're very grateful for your interest. We think that 2017 will be a great year. We're really pleased to have Gregg with us and look forward to seeing or speaking to each of you again soon. Thank you for your interest. Take care.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time. And have a wonderful day.