CSW Industrials Inc (CSW) 2017 Q3 法說會逐字稿

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

It is now my pleasure to introduce your host, Tom Cook. Thank you, Mr. Cook, you may begin.

Thank you, Doug. Good morning, everyone, and welcome to CSW Industrials' fiscal third-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, 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 materially differ because of factors discussed in today's earnings release, in the comments made during this call, and in the risk factor section of our annual report on 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, net income, and earnings per share, which are non-GAAP financial measures of performance. These non-GAAP measures should be viewed 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 operating income, net income, and earnings per share, see our earnings release.

I would now like to turn the call over to our Chairman and CEO, Joe Armes.

Thank you, Tom. Good morning, everyone. Thank you for joining us on our call today. During our third fiscal quarter, we continued to make progress on our long-term objectives of integrating our business and driving synergies across CSWI.

Much like the prior quarter, our operating results were affected by discrete end-market exposures and their respective cycles. However, unlike the prior quarter, I am pleased to report that we grew consolidated sales by 6.5%, including 6.2% organic growth during the period, while adjusted net income grew by 9.9%.

Higher profit levels were primarily the result of higher sales and margins in our industrial products and specialty chemicals segments. Within industrial products, these improvements were driven by continued growth in our large smoke curtain product categories coupled with strong contributions from HVAC, plumbing, and other architecturally specified building products.

In our specialty chemicals segment, trends improved during the third quarter, as a 10% sales growth rate, operating leverage on higher volume, and contributions from our cost-savings initiative all contributed to improved segment-level performance year over year. Consistent with our expectations articulated last quarter, sales for Jet-Lube and Whitmore products were inflated during the third quarter by approximately $1.5 million as we burned off excess backlog associated with our Houston facility consolidation.

Turning to coatings, sealants, and adhesives, we are in the earlier innings of our restructuring efforts. Rail volume has still not recovered, and startup volume of new products had an unfavorable effect on mix during the period.

On the top line, we were pleased to see a meaningful moderation in the pace of the segment revenue decline as our sales diversification efforts begin to offset lost volume in rail. However, this effect did create margin pressure during the period and our adjusted operating margin declined 480 basis points to 5.7%. Looking forward, we expect the previously disclosed termination of an inefficient toll manufacturing arrangement and facility consolidations to improve margins as each of these initiatives take hold.

Recognizing the need for strong leadership during this pivotal time, I have asked Chris Mudd to take full leadership of this segment on an interim basis. And he will outline his broader operating plans for this division in a few moments.

Next I would like to give an update on our end markets, beginning with commercial and residential construction. This continues to be our strongest performing end market, supported by a robust macro backdrop, and we have been growing in excess of category rates, thanks to the market success for a number of our products. The third quarter was no exception, as we booked increased revenue for large smokescreens, including a high-profile installation for a Netflix original content facility located in Hollywood, California.

In our energy-related end markets, rig counts are up substantially since the trough in energy prices. And while we are beginning to see some growth in this area, the lag time between rig count improvements and product consumption results in an uptick rate that is slower than the oil and gas market generally. We expect this will correct over the coming quarters as we move past this phase, which is usually 6 to 18 months, depending on product and end market.

Turning to our rail end markets, demand for OEM railcars and locomotives continues to be under significant pressure and we are not seeing signs of improvement through the third quarter. As Chris will detail later, we are working diligently to diversify end-market exposure in our coatings business to help reduce the volatility going forward. Similarly, in rail lubricants, we are seeing volume pressure as result of mid-single-digit declines in track volume, although at a more moderated pace than railcar manufacturing volumes.

In our general industrial end markets, which covers a broad range of applications and products, volume is a bit of a mixed bag. We no longer see declining markets, but rather flat markets. There are several puts and takes to our industrial end markets, and our team has been doing a good job at managing the business appropriately and diversifying into new markets.

And finally, we are beginning to see some green shoots in our mining end market, but aggregate volumes are still modestly lower year over year. However, the impact this has on our consolidated results is muted, as this is now our smallest end-market exposure.

So to summarize, the major end markets we serve are improving. Some are healthy and experiencing strength, with the exception being rail, which has created some significant pressure in our coatings, sealants, and adhesive segment. As a consequence, we are aggressively rationalizing our operations and diversifying our revenue exposure in that segment.

Now I will turn the call over to Gregg for a closer look at the numbers.

Thanks, Joe, and good morning, everyone. Our consolidated fiscal third-quarter revenue increased 6.5% to $75.5 million compared to the prior-year period of $70.9 million. The increase was primarily attributable to increases in construction markets and the burn off of excess backlog following the Jet-Lube facility consolidation, partially offset by decreases in the rail and energy markets.

Looking at our segment-level revenue and operating income, industrial product segment revenue increased 11.3% during the quarter to $31.7 million compared to the prior-year level of $28.5 million. The increase in revenue was the result of strength in the construction market, including higher HVAC volume and deliveries of large smoke curtains.

Industrial product segment operating income was $4 million compared to the prior-year level of $3.4 million. Adjusted operating income was $4.3 million compared to $3.4 million in the prior year and marked a 150-basis-point improvement in segment-adjusted operating margin to 13.5%.

Coatings, sealants, and adhesives segment revenue decreased 1.9% to $23.8 million compared to the prior-year level of $24.3 million. Lower revenue was mainly attributable to decreased sales volumes in the rail end market. Although lower rail activity continued to pressure our segment-level top line, we were encouraged to see a sharp deceleration in the pace of decline as revenue from our sales diversification efforts began to offset this discrete end-market impact.

Segment operating income in the third quarter of 2017 was $813,000 compared to operating income of $4.2 million in the prior-year period. Adjusted operating income was $1.4 million or 5.7% of sales compared to $2.5 million or 10.5% of sales in the prior year. The decrease was attributable to lost leverage on lower sales and an unfavorable mix on startup volume on sales diversification products.

Turning to specialty chemicals, revenue increased to $19.9 million compared to the prior year of $18.1 million. Higher sales were attributable to working down the backlog of Whitmore/Jet-Lube products related to the facility consolidation, which added approximately $1.5 million to segment sales as well as revenue from acquisitions, partially offset by weaker demand for rail lubricants.

Segment-level operating income in the third quarter of 2017 was $541,000 compared to the prior-year level of $1.7 million. Adjusted operating income in the third quarter of 2017 increased to $2.8 million compared to the prior year of $2.2 million and marked a 170-basis-point increase in segment adjusted operating margin to 14.1%. Higher adjusted operating margin was mostly related to leverage on higher volume and incremental savings related to our restructuring programs, partially offset by negative sales mix.

Consolidated gross profit in the third quarter of fiscal 2017 was $28.9 million. Gross margin as a percentage of sales decreased to 38.3% compared to 45.3% in the prior year. The decline was due to an unfavorable sales mix shift, reduced absorption on fixed manufacturing costs and products sold into the rail and energy markets, restructuring and realignment costs incurred related to rationalization of our manufacturing footprint.

Consolidated operating expenses decreased to $25.5 million or 33.8% of sales compared to the prior-year level of $26.5 million or 37.4% of sales. The decrease was primarily attributable to organizational and startup costs incurred in connection with the shared distribution and transaction costs from the Deacon and Leak Freeze acquisitions recorded in the prior year that did not recur.

These costs were partially offset by the Strathmore acquisition earnout liability reversal recorded in the prior-year period that did not recur, and current-period restructuring and realignment costs coupled with costs as we become SOX compliant.

Consolidated operating income was $3.4 million or 4.5% of sales compared with $5.6 million or 7.9% of sales in the prior year. The lower operating income was primarily attributable to a $3.3 million decrease in gross profit, partially offset by the $1 million decrease in operating expenses as previously discussed. Adjusted operating income was $6.6 million, which was flat when compared to the prior-year period.

Consolidated net income for the third quarter was $405,000 or $0.03 per diluted share compared with net income of $2 million or $0.13 per diluted share in the prior-year period. Adjusted for one-time items and a normalized tax rate, net income was $4.2 million or $0.26 per diluted share compared to net income of $3.8 million or $0.24 per diluted share in the prior year.

Our net debt at quarter end was $24.7 million. We closed the quarter with $22.2 million of cash on our balance sheet and had $265.9 million of borrowing capacity on our revolving credit facility, providing ample flexibility to fund our growth and acquisition strategy.

Now I will turn the call over to Chris Mudd.

Thanks, Gregg. I'd like to begin today by providing an update to our corporate-wide integration initiatives, followed by discussing coatings, sealants, and adhesive, and close by touching on some other Company highlights.

We can group our strategy into two distinct paths. The first includes the coatings, sealants, and adhesives and specialty chemicals businesses, where our current objectives are in rationalizing our operational footprint and expanding sales of existing products into new regions with broader end-market exposure.

The other path is within our industrial products business, which we are focused on cross-selling and the expansion of our product line, which I will explain as we go through the segments individually.

As we have previously communicated since the spinoff transaction, we have identified approximately $10 million to $11 million in annual savings, driven primarily via facility consolidations and our global procurement initiatives. And we have continued to make incremental progress on these programs throughout the quarter. Across the organization, we remain confident in our ability to generate approximately $2 million to $2.5 million in annual savings, as previously communicated, through our procurement programs.

In specialty chemicals, we expect to achieve a $5.5 million annual savings run rate by April 1, 2017, inclusive of the consolidation of Jet-Lube Canada. The balance of the $10 million to $11 million savings will be realized by manufacturing footprint consolidation in the coatings, sealants, and adhesives segment, which I will revisit in a moment.

As part of our sales diversification initiative, we have begun gaining traction in Southeast Asia and China, where we have begun penetrating markets in this region. Examples of this would be the use of our products in cement and sugar mill plants in Asia, and also in Latin America, where our products are being used in the mineral and mining end markets.

Moving to an update on coatings, sealants, and adhesives, and to which Joe briefly alluded in his remarks, I have assumed leadership of this segment on an interim basis. This segment is much earlier in its restructuring, and following some leadership changes, we made the decision that I would take direct leadership of the segment through the restructuring completion. As part of this, I have been conducting customer meetings to review the quality and efficacy of our products, and the feedback I have received has been very positive.

At the same time, we are seeking to deepen the relationships with our customers through these conversations. We have also made progress in the recruitment of key sales team members during the quarter who we believe will allow us to penetrate new markets and increase our presence in markets where we have traditionally been underrepresented.

This coatings segment transformation has two primary objectives. First, as we have discussed, we are restructuring the business to optimize our operations and improve our cost profile. This includes the consolidation of production from our two Syracuse, New York, facilities into our Longview, Texas, and Acworth, Georgia, facilities, and bringing the expensive Houston tolling arrangement in-house to our Longview, Texas, facility. In the aggregate, we expect these programs to provide annual savings of $2 million to $2.5 million and expect to achieve this run rate in fiscal 2018.

In parallel to these cost-saving measures, we are also working diligently to drive revenue expansion through our sales diversification efforts, cross-selling, and expanding sales with current customers. Our sales teams have responded well to the revised compensation structure we implemented earlier this fiscal year.

And we have seen positive traction in new markets which the Company has not previously entered, including coatings for propane tanks, railcar liners, energy storage tanks, and industrial racks, to name a few. In the coming quarters, we hope to provide a larger update on these markets where we see potential for greater growth.

Specifically within industrial products, we are seeing success with our go-to-market strategy in a variety of products, such as smoke curtains, our portfolio of building safety products, and other custom solutions which we have discussed previously. Our team does a nice job of working in tandem with architects and general contractors to come up with solutions that enable compliance with building safety codes and yet are still attractive in design.

Traditionally, CSWI has used M&A as our R&D, but within this segment, we have been able to really evolve and generate great products and solutions through our research and development team. We have gathered positive feedback from our customers, architects, and general contractors who have been involved with the process, which is something we take pride in.

Turning to new initiatives, during the quarter, we commenced a program to improve our working capital efficiency. We hired an experienced supply chain professional to lead our newly formed supply chain steering committee, which will review our business segments and help improve our inventory turns, allowing us to become nimbler in our operations, and to capitalize on the efforts Gregg and his finance organization previously identified as an area for improvement. While it is a little early to set to formal targets, we expect this to provide an incremental boost to our free cash flow in the coming year.

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

Thank you, Chris. In closing, we are focused on driving growth and healthy end markets such as our construction-related end market, and exploiting a healthy macro backdrop while we are navigating through challenged commodity-related end markets and reducing cost where appropriate. As I've said before, our broadly diversified product portfolio and end-market exposure provide stability under all market conditions, and that was once again demonstrated here in the third quarter.

Our balance sheet remains strong. We are building a team capable of executing on our long-term strategic priorities. Through these actions, we believe we are taking the right steps to manage through the various cycles and position the Company to deliver long-term, sustainable value creation for our shareholders.

Now I would like to take the 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 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.

Thank you for taking my questions. To start, in your specialty business, can you update us on the mix between drilling and completion and production? And how each one of those are doing from your point of view, and maybe what the lag looks like, if and when drilling does recover?

Yes. The traditional products like copper coat is a drilling compound, and that is related primarily and driven primarily by rig count. There are other products that are more production-oriented that the name brand would not mean much to investors, but we do have those production -- products that are related to production.

So, while production has remained, obviously, more stable than the rig count, the rig count is up pretty dramatically from the lows, and we are beginning to see demand rise there. The delay or the lag time there affects us, but we are beginning to see that growth.

And then I would also add that those products such as copper coat have been nice margin products for us, historically. And so we would expect that to come back as the volume comes back as well.

Okay, thanks. And just moving on to the CSA segment regarding the margins. The new products that you are ramping, are those just inherently lower margins than the previous ones? Or is it just they drag from startup costs related to getting those up to speed and volume?

Well, it's a little bit of both. But certainly, the more transactional business is lower-margin business. And so we have had an initiative to go out and aggressively pursue that business in order to fill up the plant, to add to the diversified revenue base. And then we think we will -- over the longer term, we will migrate back toward the higher-specification items and products that have a longer sales cycle and higher margins.

Got it, that's helpful. And just on the efforts to diversify your customer base in that segment, can you just update us on the potential for added revenue? I think the last time you spoke, you said it was a $6 million opportunity that you are ramping towards. Can you just quantify the results-related efforts there?

Yes. We are continuing to make progress in that direction. And as Joe mentioned, much of that is going to be transactional in nature with shorter qualification times. And so we're continuing to be pleased with our progress in that direction.

But I think we are still tracking to that $6 million-plus at this point.

That's true.

Okay, great. And then finally, just an update on the pipeline for M&A. What are you seeing in terms of availability, valuations? Anything you can give us that would be helpful.

Yes, haven't seen a lot of change in that area. We continue to pursue acquisitions. We continue to take a disciplined approach. Valuations are still high. And to date, we have not found the right opportunity at the right value.

Having said that, we continue to pursue aggressively and with a real focus on the industrial products segment as being an area of historical growth that we would like to exploit going forward as well. But really no change from the last couple quarters.

Great. Thank you again.

Liam Burke, Wunderlich Securities.

Joe, I know that, one, early 2017 is not a trend. But we are seeing rail traffic volumes modestly pick up, probably stabilize. Could you give us a sense of timing, if this trend continues and we see rail volumes up maybe 1%-2%, what the sequence would be of the recovery of the lubrication in the Whitmore systems business?

Yes, Liam. I think that's a great question. I think that obviously track miles or the utilization there by the rails will drive the lubrication needs, the miles carried. We are hoping to see additional cash that will be invested into the operations there.

Our products promote efficiency. They promote longevity of the asset life and reduce wear and tear on both the rail and the wheels. They can reduce noise. There's a lot of attributes there that are very valuable if the rails are healthy. And so if they could see an uptick in track miles, we would expect to see that as well.

We do believe that the specialty chemical segment will see positive turnaround there quite a bit before the coatings, sealants, and adhesives business will, the OEM manufacturer of the railcars. So that would be the area to be focused on and hopefully would be earlier in the cycle, as that business picks up.

Great. And on the HVAC side, are you still seeing a healthy uptick in ductless mini splits driving that HVAC business?

Absolutely. In fact, I was just at the big air-conditioning show last month in Las Vegas, and it's incredible to see the number of mini splits on display. It is the exciting technology in that industry.

This is OEMs that manufacture these, and they all need to be installed. We had really nice traffic at our booth and a lot of interest in our new products that support ductless mini splits and really just HVAC in general. So it's a great end market for us.

Chris, you might also mention the Leak Freeze new applicator and the buzz around it at the show.

Thanks, Gregg. There are -- as you might remember, we made an acquisition at the end of 2015 of AC Leak Freeze. At that time, our strategy was to come up with a new, more contractor-friendly application method.

We've come out with that. We spent some time trialing that in the field and officially launched it at the show. And we are going to have some preseason promotions coming up next month. And just a lot of buzz around the new AC Leak Freeze Pro product line, which we expect to be a big seller this coming HVAC season. This is the one that stops leaks in the air-conditioning units.

Sure. Okay. Well, thank you, Joe. Thank you, Chris.

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

Right. Once again, we just want to say thank you very much for your interest. We appreciate your participating in the call today; look forward to doing it 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.