CSW Industrials Inc (CSW) 2017 Q1 法說會逐字稿

Greetings and welcome to the CSW Industrials, Inc. first-quarter 2017 earnings call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Tom Cook with ICR. Thank you. Mr. Cook, you may begin.

Thank you, operator. Good morning, everyone, and welcome to CSW Industrials' fiscal first-quarter investor call. Joining me today are Joseph Armes, Chief Executive Officer of CSW Industrials; Greg 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 the "Risk Factors" section of our annual report on Form 10-K and other filings with the SEC. We do not take any duty to update any forward-looking statements.

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

I will now turn the call over to our Chairman and Chief Executive Officer, Joe Armes.

Thank you, Tom. Good morning, everyone. Thank you for joining us on the call today.

We experienced a challenging first quarter of fiscal 2017. Volumes in energy-related end-markets remained at trough levels and our exposure to rail end-markets came under significant pressure, which our customers have largely attributed to indirect exposure to weaker commodity markets. During their recent earnings calls, our customers have announced reduction in new railcar production of approximately 50%, which had a direct correlation on our sales decline and products sold into the rail manufacturing markets. There has also been a drop off of almost 12% in car load traffic, which has negatively impacted sales of rail lubricants.

With that being said, when assessing our first-quarter results beyond the headline numbers, there were many positive and encouraging developments to highlight. First, after taking into account public company costs, which were not in the prior-year financials because we were not a public company at that time, and one-time items during the period, we were able to hold margins relatively stable compared to the prior year. This stems from the collective work of our management teams across our operating segments to reduce costs, combined with the strong performance in our non-energy-related end-markets, namely in our industrial products segment.

Second, we made progress toward diversifying our end-market exposures in our coatings segment and we expect new customers to contribute revenue of about $6 million annually on a run rate basis as we ship products to these new customers throughout fiscal 2017. While this volume did not benefit the current quarter, we were very pleased to see this level of quoting and order activity and new applications for our products.

Third, we are proud to announce that Strathmore was recently named the coatings supplier of the year by Trinity Industries, an important customer to our coatings segment. This award highlights the quality of our specialty coatings products and strengthens our view that despite near-term cyclical challenges, coatings remain a compelling opportunity for long-term growth.

And, lastly, the R&D investments that we have made in our architecturally-specified products division for large-scale smoke curtains have resulted in new revenues exceeding our expectations. These innovative products can be found in marquee projects, including most recently the San Francisco Museum of Modern Art, as well as projects for Facebook and Netflix.

While our industrial products segment has earned a stellar reputation for successfully identifying and executing bolt-on acquisitions, we believe this recent success in smoke curtains is a testament to our ability to drive organic growth through our product development efforts and the enhancement of existing products.

Taking a deeper look at the financial performance in the first quarter, we can summarize our results by two contrasting themes.

First, demand for our products supporting HVAC and architecturally-specified building products showed continued strength and delivered record-setting volume in multiple categories. This tailwind was offset by lower volume in rail, energy, and general industrial end-markets, which was predominantly driven by direct and indirect exposure to lower energy and other commodity prices. Together this led to a 5.4% decline in consolidated revenue to $84.1 million.

Covering these themes individually, strength in HVAC, plumbing, and construction-related products drove almost a 9% revenue increase in our industrial products segment, while strong margin performance increased segment-adjusted operating income by almost 11% to $10.8 million. Despite our new operating structure having limited operating history to highlight the magnitude of this performance, I will note that HVAC, plumbing, fire, and smoke protection products all achieved record sales level in the first fiscal quarter.

In our specialty chemicals and coatings, sealants, and adhesives segments, depressed commodity prices accounted for top-line weakness in both segments. As has been reported by several of our OEM customers, railcar production volume has declined approximately 50% compared to the prior year, which has led to a corresponding reduction in demand for our specialty coatings given our current exposure to these markets. This reduction in volume has been mostly attributed to a decrease in the commodity markets and its impact to lower track cargo volume, which also affected demand for our specialty retail -- our specialty rail lubricants.

Primarily as a result of these dynamics, sales in our coatings, sealants and adhesives, and specialty chemicals segments were down 17.7% and 14.8%, respectively.

Looking to the balance of the year, we do not expect meaningful improvement in these end-markets and have consequently commenced a program to further rationalize our footprint and reduce costs in our coatings, sealants, and adhesives segment. Chris will add some specifics in a moment, but we expect this initiative to provide an annualized savings of between $2.5 million and $3 million and to reach a full run rate by Q4 of this fiscal year.

Turning to profit in the quarter, as I noted, we were pleased with our ability to maintain segment-level profitability despite significant pressure in two of our three segments, which was evidenced by total segment-adjusted operating income of $15.2 million, or 18.1% of sales, compared to $16.5 million, or 18.6% of sales, in the prior-year period. At a consolidated corporate level, excluding one-time items, our adjusted operating income declined to $12.4 million compared to $16.5 million in the prior year as the comparable period did not include public company costs or the investments we have made into our corporate infrastructure.

Looking forward to the balance of the year in our end-markets, we expect the predominant themes of the first quarter to persist through fiscal 2017. We are optimistic that our industrial products segment will continue to drive performance, which is supported not only by a robust market, but also by continued progress toward the integration of recent acquisitions and the continued success from new products that we have introduced or will be introducing soon.

In our specialty chemicals segment, we believe volume in energy end-markets is stabilizing, but will remain at reduced levels, while a weaker overall commodity backdrop will indirectly pressure demand for our rail and industrial lubricants. In our coatings, sealants, and adhesives segment, lower OEM railcar production rates are expected to persist, but we do expect our revenue diversification efforts to moderate volume pressures as the year progresses and the planned facility consolidation that Chris will discuss in more detail later to significantly reduce our costs and improve profitability.

It's a challenging environment, so we are focused on the factors that we can control and view our efforts to react quickly to changing market dynamics as a high priority and a core competency of our senior leadership team. We see a clear path ahead of us to manage through the difficult environment in energy and rail and to fully capitalize on the potential of our commercial and residential construction end-markets.

With that, I will turn the call over to Greg for a closer look at the numbers.

Thanks, Joe, and good morning, everyone. Before digging into the numbers, I would like to provide an update on our financial initiatives to migrate from six individually-managed private businesses to a single integrated operation with a centralized financial support system. These efforts are designed to streamline our reporting, provide real-time information, improve management tools through enhanced analytics, and enhance our reporting and transparency to the investors.

Prior to my arrival last quarter, the team was in the process of rolling out a new consolidation system, which enables centralized reporting on a shared system. I'm happy to report that as of the first quarter we have completed phase one of this integration and we were able to close the quarter on the new system. This is a significant first step as it included an integration effort at all of our operating locations.

Phase two, which is currently underway, includes the designing and implementation of a new set of analytical tools to improve our understanding and reaction time to market events. And we expect to see the benefits of this with our second-quarter close and further enhancement through the balance of the year.

Since my arrival, I have completed site visits at nearly all of our operating locations and have collectively worked with financial leadership across the organization to identify relevant operating metrics, which we believe will prove valuable for internal and external analysis. In addition to the metrics, I am working with our financial team and our external consultants to ensure we are Sarbanes-Oxley and COSO 2013 compliant by the end of the fiscal year.

While we still have a lot of work ahead of us, we expect to provide progress updates throughout the year and rollout new analytical measures to help investors understand financial results at the completion of phase two.

Now turning to our financial discussion of the first quarter, I would like to remind everyone that I will be referring to our adjusted results that exclude one-time items where noted. These adjustments primarily exclude restructuring charges, costs related to the CFO transition that took place during the quarter, and other one-time items during the period. For a full reconciliation of GAAP to non-GAAP results, please refer to our earnings press release on our website.

Consolidated fiscal first-quarter revenue decreased 5.4% to $84.1 million, compared to the prior-year period of $88.9 million. Lower sales in the quarter were primarily attributable to decreased volumes in our coatings, sealants, and adhesives and specialty chemicals business segments. Specifically, within the energy and rail end-markets. This was partially offset by higher volumes in HVAC and architecturally-specified building product end-markets and incremental revenue from acquisitions completed in the past 12 months.

Now looking at our segment-level revenue and operating income, revenue in our industrial products segment increased 8.8% to $43.5 million compared to $40 million in the prior period. The increase in revenue was a result of higher sales volumes and favorable pricing and mix. Our industrial products segment adjusted operating income increased 11.1% to $10.8 million over the prior-year level of $9.7 million. Segment-adjusted operating margin improved 50 basis points to 24.7% during the period.

In our coatings, sealants, and adhesives segment, revenue decreased to $23.4 million compared to the prior-year level of $28.4 million, or a 17.6% decline. Lower sales were mainly attributable to decreased OEM railcar volume, partially offset by increased sales of fire-stopping, sealant products, improved pricing, and net revenues attributable to acquisitions. Segment-adjusted operating income in the first quarter of 2017 decreased to $2.6 million compared to $4.1 million in the prior year, primarily as a result of lower sales volume and reflected a segment-adjusted operating margin of 11.2%, marking a 320 basis point decrease compared to the prior year.

In the specialty chemicals segment, revenue decreased $17.2 million compared to the prior-year level of $20.2 million, or 14.9%. Lower sales were attributable to weakness in energy and rail end-markets, partially offset by increased sales from acquisitions.

Segment-adjusted operating income in the first quarter of 2017 decreased to $1.8 million compared to the prior-year level of $2.7 million and marked a 310 basis point reduction in segment-adjusted operating margin to 10.4%. The lower segment profitability was the result of lower volume and an unfavorable product mix.

Consolidated gross profit in the first quarter of fiscal 2017 was $38.2 million, a 5.5% decrease compared to the prior-year level of $40.4 million. As a percentage of sales, gross margin was approximately flat at 45.4% compared to 45.5% in the prior-year period. The unfavorable impact of decreased sales on our absorption and fixed manufacturing cost was mostly offset by changes in product mix and benefits from strategic initiatives to rationalize the Company's global footprint and achieve cost savings through our procurement program.

Consolidated operating expenses increased 17.7% to $30.8 million, or 36.6% of sales, compared to the prior-year level of $26.2 million, or 29.4% of sales. Increased operating expenses were attributable to our CFO transition and other severance costs, other personnel and public complete costs as the prior-year quarter did not have most of these public company costs, and restructuring costs associated with the consolidation of facilities. This was partially offset by transaction costs in the prior year that were non-recurring.

Fiscal first-quarter 2017 operating income was $7.4 million compared to the prior-year period of $14.3 million. On an adjusted basis, operating income was $12.4 million compared to the prior-year level of $16.5 million. Adjusted operating margin declined 390 basis points to 14.7%, compared to the prior-year period of 18.6%, which entirely reflected costs associated with being an independent public company and investments we have made in our corporate infrastructure, as prior-year results were on a pro forma basis prior to the spinoff of Capital Southwest.

Consolidated net income for the first quarter was $4.1 million, or $0.26 per diluted share, compared with net income of $8.7 million in the prior-year period. Net income included approximately a $600,000 gain in other income, which resulted from the sale of nonoperating assets and a favorable impact from foreign currency hedges.

While we generally have minimal exposure to foreign currency, during the first quarter we identified a possible risk in our cash holdings and successfully protected around $6.5 million of pound sterling and avoided a $1 million translation loss ahead of the British exit from the European Union through a forward hedge and converting some of our pound sterling to US dollars.

Adjusted for one-time items and a normalized tax rate, net income was $8 million, or $0.51 per diluted share, compared to net income of $10.1 million, or $0.65 per diluted share, in the prior year. Our net debt at quarter-end was $49.6 million and we closed the quarter with $34.9 million of cash on our balance sheet and had $178.5 million of borrowing capacity on a revolving credit facility, providing plenty of flexibility to fund our growth and acquisition strategy.

Now I will turn the call over to Chris.

Thanks, Greg. I'd like to begin today by providing an update on our corporate-wide integration initiatives followed by some additional details of a restructuring plan we are initiating in our coatings, sealants, and adhesives segments.

As we have communicated previously, since the commencement of the spinoff transaction, we have identified $7.5 million in annual savings, primarily through facility consolidations and our global procurement initiatives. I am pleased to report that we have made significant progress towards these programs.

As of the end of the first quarter, we have ceased virtually all production in our Jet-Lube Houston facility and have completed the closure of Jet-Lube Canada. While it will take some time to fully realize the $5.5 million in savings under this initiative, we did realize some modest benefit in the first quarter and will be in a position to realize the full run rate by April 1 of 2017.

Regarding our companywide procurement program, we have put in place new purchasing agreements that will yield more than $2 million in annual savings we previously communicated and we continue to identify additional opportunities beyond our original commitments. As a result of the additional opportunities, we now anticipate saving approximately $2.5 million in fiscal 2017. The benefits of this program resulted in savings of $600,000 in the first quarter.

As you may recall, last quarter we detailed a path to improve profitability in our coatings business and we have reached several milestones. First, of the $2 million in procurement savings companywide, $1 million of that savings was expected in the coatings, sealants, and adhesives segments. I am happy to report that as of quarter-end we've already achieved a run rate of around $750,000 annually.

Second, we continue to make progress towards the exit from our expensive toll manufacturing arrangement in Houston and this should be complete by the end of October of this year. Third, we have closed one of the manufacturing facilities in Syracuse, New York, as planned last year.

And, fourth, we have launched a sales diversification program in an effort to reduce cyclical exposure to the OEM rail market. As Joe mentioned, we had some considerable success in this area and were selected by multiple new customers in end-markets which include coatings for industrial racks, propane storage tanks, above-ground storage tanks, and automotive filter applications. In total, we expect sales to these new customers to amount to around $6 million per year going forward.

In addition to these previously-disclosed initiatives, we announced in our earnings release today additional programs to further restructure the business given the recent volume declines and current market conditions. These incremental actions further optimize our manufacturing footprint by reducing our manufacturing locations and relocating certain manufacturing to maximize efficiency.

In total, we estimate this restructuring will produce between $2.5 million to $3 million in annual additional savings. We expect to complete these additional programs by the end of the calendar year, which will include some one-time restructuring costs, which we estimate to be in the range of point $2.5 million to $3 million and capital investment of between $1 million to $1.25 million.

Before turning the call over for your questions, I wanted to close by providing an update more broadly on progress that we have made to deepen our team and drive excellence across the business. As you know, we restructured our leadership team and appointed segment leads several months ago, and in the first quarter we continue to build out and upgrade our staff at the next level down. This includes a new VP of sales in our industrial products segment and in our coatings business, which now includes several new team leads in the area of sales, business development, and quality assurance.

So with that, I will turn it over to Joe for closing remarks.

Thank you, Chris. In closing, although we acknowledge a challenging quarter, we would also note that our broadly diversified portfolio of products and the diversity of our end-market exposures provided stability under stressed market conditions. Our balance sheet remained strong and we are building a team able to execute on our long-term strategic priorities under any market conditions. We believe we are taking the steps necessary to manage through the current cycle and to position the Company to deliver long-term sustainable value for our shareholders.

Let me take this opportunity to thank all of my colleagues at CSW Industrials as we continue to serve our customers and to steward well the capital entrusted to us by you, our shareholders. Thank you for your interest in CSW Industrials and now, operator, we are ready to take questions.

(Operator Instructions) Jon Tanwanteng, CJS Securities.

Good morning, gentlemen. Thank you for taking my questions.

Can you talk about the timing and the margin profile of the new businesses you are seeing in coatings? How do you expect that to ramp?

This is Chris. It's going to ramp through the year. This is business that is additional incremental business in new markets. The question was more on timing or the (multiple speakers)?

Timing and the margins, as well.

Margins are going to be in line with typical coatings margins and the timing will be phased in over the course of the year. It's not always 100% in our control, but we certainly expect to see this additional incremental sales revenue as we roll out through the rest of this fiscal year.

Okay, great. Just to clarify, the $2.5 million to $3 million in run rate savings you are expecting, is that in addition to the previous synergies in savings you discussed of $7.5 million?

Yes, it is. This is in addition and this is really in the coatings, sealants, and adhesives segment.

Okay, got it. So over the end or by the end of the fiscal year about $10.5 million is what you're talking about?

This is Greg, Jon. Yes, it would be between $10 million and $10.5 million on a run rate basis as we exit this fiscal year.

Got you, okay. And just a quick question on the corporate expenses. Ex-items you did $2.8 million in the quarter. Is that the run rate we should expect going forward and should we continue to expect additional one-time expenses like the Sarb-Ox consulting fees?

The Sarb-Ox and consulting fees, primarily the Sarb-Ox I think we'll see some additional consulting as we continue to roll that out and become compliant this year. The one-times on that are probably more heavily weighted to the first quarter, as we were in the process of designing the controls and putting systems in place, but we will see a little bit more of it throughout the rest of the year.

As to the run rate of the corporate expenses, I would say that those are higher than what we would expect, both with and without the one-times, as we saw some timing of costs relative to some financial and professional fees relative to the audit, taxes, things of that nature that tend to be more heavily weighted in the first quarter.

Okay, great. That's helpful. Finally, can you just update us on the M&A environment, maybe what you are doing from a due diligence standpoint to avoid things like Strathmore? And how active are you in general?

This is [John]. We are very active in looking for acquisition opportunities. Similar to our statement on last quarter's call, the market continues to be a tough environment to find value. Valuations have been stretched and we are committed to a very disciplined approach.

And so, at this point, we have not identified -- we haven't closed any acquisitions because of valuations in large part, but we are very active looking. Primarily what we are looking for are strategic add-on acquisitions: acquisitions that allow us to leverage our distribution channels, acquisitions that would be oftentimes described as product line extensions. And so those are the type of acquisitions that we are looking for.

If we can find those at a reasonable value, then we would be very interested in that. However, at this point, valuations seem pretty high to us.

Okay, great. Thank you.

Liam Burke, Wunderlich.

Thank you. Good morning, Joe. Good morning, Chris. Joe, on the fall off on the rail business, obviously the traffic volumes are what they are as well as the carload production, but is this just a volume decline? Are you seeing any pricing pressure in either of those areas, either in the coatings or the friction management side?

Fortunately, we have not. We have really seen really a decline in the orders from customers and their decline in their business. We have not seen price decline and we have not -- pricing pressure and we have not lost share, to our knowledge. It appears to us that we are down in lockstep with the industry.

Great. When I'm looking at the broader industrial markets -- you highlighted weakness in your prepared comments. Are there any pockets of strength under that -- it is a pretty, obviously, broad category, but do you see any strength in that industrial category that you laid out?

This is Chris, Liam. It's tough to say specifically. The industrial segment is a very broad brush that we use to describe everything that's not one or the other end-use markets, so I can't really pinpoint one specifically that would be an island of strength in the industrial end-market.

In that area, do you see any continued momentum in new product introductions in that space?

Obviously, we highlighted in the industrial products area, in the industrial products segment we talked about our new large-screen curtains, which has been a nice success story and something that we just introduced really last fiscal year. And we are starting to see a nice uptick in that business.

So I guess the other -- just to kind of touch upon themes we've hit in previous quarters, Liam, we continue to introduce some of our new products, like the Deacon Sealants, into a broad range of industrial end-markets. And we are starting to see some uptick there through our distribution channels, so we are excited about that. And we believe that is going to be an area of strength going forward is to be able to get those products into the hands of a broad range of industrial customers.

Great, thank you.

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

Great. Thank you again for joining us. We appreciate your interest and look forward to speaking to you again next quarter. Thank you.

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.