CSW Industrials Inc (CSW) 2017 Q4 法說會逐字稿

Greetings, and welcome to CSW Industrials' Fourth Quarter 2017 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to turn the conference over to Sarah Bicknell from ICR.

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 had 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 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 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 operating income, net income and earnings per share, see our earnings release.

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

Thank you, Sarah. Good morning, everyone, and thank you for joining us on today's call.

I would like to begin our call with a few highlights from the quarter and discuss our outlook for 2018. Then, Gregg will take you through the financials and Chris will discuss the operational highlights for the quarter.

We're pleased to report that we ended the year on a strong note with top line growth in all 3 segments. Revenue was up 14.5% at a consolidated level for the quarter on organic growth of 12.9%. Our fourth quarter adjusted earnings per diluted share were $0.43, which was up 22.9% compared to the prior year, led by a strong performance in our Industrial Products segment. Our consolidated operating results continue to be affected by challenging volume in rail and mining, but we see this pressure lessening in rail and a modest recovery in energy.

For the full year and on a consolidated basis, our sales grew by 2.3%, including 0.6% organic growth during this period, while adjusted net income decreased by 1.3% to $26.7 million or $1.68 per diluted share. I would remind our investors that the prior year included only 6 months as a stand-alone company, which created a $0.21 headwind to our adjusted EPS and is not contemplated in our adjustments as it is recurring.

As we close out our first full fiscal year as a public company, I wanted to take a few moments to recap the progress we've made since we spun out of Capital Southwest in September of 2015. Our business was comprised of 6 independent portfolio companies that all served industrial end markets, but were not integrated despite having a common owner. Our goal since the spin had been to integrate these disparate businesses into 3 business segments with enhanced efficiencies, leverage a stronger shared capital structure and execute attractive acquisitions in the end markets we serve to leverage our distribution channels.

As part of this reorganization, our team took a critical look at opportunities for cost savings and footprint optimization. We identified several areas where we could rationalize our footprint and find cost savings and have been executing on this strategy. We view this as a 2-step process: The first, rationalize; and then, refine our operations to deliver increased value for our customers and shareholders. As we turn to fiscal 2018, our most significant rationalization work is behind us.

In our Industrial Products segment, we completed the acquisition of Greco Aluminum Railings in the fourth quarter. Greco is a leading manufacturer of high-quality engineered railing and safety systems for multifamily and commercial structures and is based in Canada. And I'm pleased to report that the business is performing ahead of our expectations in our first few months of ownership in all respects and we are continuing to see strong bookings for that business.

This acquisition falls right in the middle of the fairway for our acquisition criteria as Greco nicely complements our architecturally specified building products business and further diversifies our offerings while enhancing cross-selling opportunities. To that end, and Chris will detail more in his remarks, we coordinated our sales efforts for our Smoke Guard and Greco products and combined our Balco and RectorSeal fire-stopping product sales efforts. This will allow us to capture share through cross-selling and balance our geographic penetration.

In our Coatings, Sealants & Adhesives segment, we're in the late stages of our integration efforts. We've exited the inefficient third party manufacturing arrangement as of our fiscal 2017 year-end and expect to have Strathmore facility consolidations completed by the end of this month. We are continuing to diversify our customer base and find new opportunities for our products and have seen some incrementally positive signs from new customers in the fourth quarter in areas such as hopper and grain railcars and industrial coatings.

Turning to our Specialty Chemicals segment. During 2017, we completed the footprint rationalization of our Jet-Lube operations and we are now producing all Jet-Lube volume out of our Rockwall, Texas production facility. In addition, the lease at Jet-Lube Houston rolled off in the fourth quarter, so we will begin to fully realize the lease and headcount reduction savings beginning in fiscal 2018.

While fiscal 2017 was very much focused on bringing all of this volume under one roof and rightsizing the business in response to market conditions, in fiscal 2018, we will endeavor to move up the learning curve and improve our operations to find efficiencies with the new volume at this facility.

Thus far, we have achieved the gross cost reductions we expected, but we are seeing some incremental costs, including increased freight, packaging and storage costs. As Chris will detail in a moment, we have identified opportunities to address these inefficiencies, reduce our working capital and we are well-positioned to capture additional synergies.

Next, I'd like to give an update on our end markets, beginning with commercial and residential construction. This continues to be our strongest performing end market as supported by a robust macro backdrop and our sales into this end market have been growing in excess of category rates, thanks to the market success for several of our products. We continue to enjoy strong revenue growth in other key end markets, particularly in HVAC and plumbing. But given the extraordinary growth rates we have enjoyed recently, we would not be surprised to see some moderation in the growth rate in the year ahead.

In our energy-related end markets, we have seen an increase off the bottom as rig counts have rebounded. Until the last week or so, we've been feeling encouraged by the price of oil and we're anticipating a nice uptick in our business during fiscal 2018 based on rig counts, which is the primary leading indicator for that business. More recently, volatility in oil markets have caused us to temper our expectations a bit.

Turning to our rail end markets. Demand for OEM railcars continues to be under significant pressure, so we are continuing to diversify our coatings product sales and find new markets to enter. We have found some success in hopper grain and other railcars which we have not historically served. At our more traditional tank car market, sales continued to be weak, but our team is highly focused on finding new wins and being well-positioned for when demand in this market recovers.

And finally, in our mining end markets, similar to rail, we are still aggressively looking at new customers and applications to diversify into, but the market remains challenged. We've had some success in diversifying geographically in this end market. We will continue to focus on these efforts in fiscal 2018 to help offset weaker domestic volume.

And with that, I would now like to turn the call over to Gregg to go over the financials during the quarter.

Thanks, Joe, and good morning, everyone.

Consolidated revenue during the fourth quarter of 2017 increased 14.5% to $87.3 million compared to the prior year period of $76.3 million. Organic growth was 12.9% and acquisitions contributed 1.6% to total growth. The increase in revenue was primarily attributable to increases in architecturally specified building products and HVAC end markets, partially offset by decreases in rail.

Looking at our segment level revenue and operating income. Industrial Products segment revenue was $41.6 million, up 22.7% compared to the prior year of $33.9 million. Higher revenue was driven by strong sales into architecturally specified products and HVAC end markets.

Operating income increased to $8.4 million compared to the prior year of $6.3 million. Adjusted segment operating income increased 52.2% to $9.6 million compared to the prior year period of $6.3 million. Segment adjusted operating income as a percentage of sales improved to 23% compared to the prior year period of 18.5%.

Coatings, Sealants & Adhesives segment revenue increased 5.3% to $26.7 million compared to the prior year of $25.3 million. Higher sales were attributable to new business associated with the company's sales diversification efforts, partially offset by lower OEM rail volume and existing -- with existing customers.

Segment level operating loss was $59,000 compared to the prior year loss of $63,000. Adjusted to exclude nonrecurring costs primarily related to realignment and restructuring, segment operating income was $1.9 million compared to the prior year period of $424,000. Segment adjusted operating income as a percentage of sales improved to 7.3% compared to the prior year period of 1.7%.

Now moving on to Specialty Chemicals. Segment revenue was $19.1 million compared to the prior year of $16.9 million. Higher sales were primarily driven by improved Jet-Lube volume due to the increased rig count that Joe mentioned plus industrial loops business in cement and power generation. Our reported segment operating loss was $817,000 compared to prior year period operating income of $3.1 million. Adjusted to exclude nonrecurring costs, segment operating income decreased $2.4 million compared to $3.1 million in the prior year.

Segment adjusted operating income as a percentage of sales was 12.6% compared to the prior year period of 18.1%. The lower profitability was due to the resolution of a customer issue in the fourth quarter and writing off some inventory, neither of which was related to the realignment and restructuring actions taken for this segment and, therefore, are not reflected in our adjusted results.

Turning back to our consolidated results. Consolidated gross profit in the fiscal fourth quarter of 2017 was $31.1 million, a 9.7% decrease compared to the prior year level of $34.4 million. Gross margin as a percentage of sales was 35.6% compared to 45.1% in the prior year period. Lower gross margin compared to the prior year reflected increased costs related to realignment and restructuring as the company improves its operational footprint. In total, we incurred $5.3 million in realignment and restructuring costs during the period.

Consolidated operating expenses decreased 4.6% to $26.4 million or 30.2% of sales compared to the prior year level of $26.7 million or 36.2% of sales. Lower operating costs compared to the prior year were primarily attributable to reduced salaries and benefits in the quarter.

Consolidated operating income for the fourth quarter was $4.7 million or 5.4% of sales compared to $6.8 million or 8.9% of sales in the prior year. Adjusted operating income was $11.1 million, a 39.8% increase compared to the prior year period of $8 million.

Consolidated net income was $2.7 million or $0.17 per diluted share compared to $1.9 million or $0.12 per diluted share in fiscal 2016. Adjusting to exclude onetime expenses and applying a normalized tax rate, adjusted net income in the fourth quarter of fiscal 2017 was up 23.5% to $6.9 million or $0.43 per diluted share compared to $5.6 million or $0.35 per diluted share in the prior period.

Our net debt at quarter-end was $48.3 million and we closed the quarter with $24.9 million of cash on our balance sheet and had $239 million of borrowing capacity on our revolving credit facility, which provides ample flexibility to fund our growth and acquisition strategy.

Now I will turn the call over to Chris.

Thanks, Gregg.

I'd like to begin today by touching on some of our operational achievements in fiscal 2017 and their implications to fiscal 2018.

Beginning with Industrial Products. This segment had exceptionally strong year as HVAC and architecturally specified building products contributed double-digit sales growth during the year. We are pleased with the Greco acquisition and it is performing ahead of our expectations. Our pipeline in this business also looks favorable as this market offers good visibility based on the long lead times from project award to build dates, similar to our other architecturally specified product offerings.

As part of the integration of Greco, we conducted a 2-day commercial meeting with our sales and marketing leaders and implemented a significant improvement in our sales efforts. During these meetings, we identified similar sales processes for Balco and RectorSeal fire-stopping products and also Smoke Guard and Greco products based on placement in the engineering time line with our customers.

As a result, we have now combined sales efforts for Balco and RectorSeal fire-stopping products and we also coordinated the Smoke Guard and Greco sales teams. This reorganization occurred to drive improved cross-selling opportunities and we've already identified -- we've already begun to see the positive impact of this in our business. In addition, we identified several geographic differences and penetration rates between products and we expect these changes will help capture higher and more consistent share across regions.

Moving to the reorganization and footprint optimization efforts. The Whitmore and Jet-Lube consolidation has been completed on schedule and, as a result, we expect to begin to realize the gross annual run rate savings that we've previously disclosed. This includes an incremental benefit beginning in the first quarter as our lease on the Houston facility rolled off at the end of the last fiscal year.

Bringing all volume under one roof and launching product manufacturing in the Rockwall facility was challenging and it consumed substantial resources during fiscal 2017. As we turn to the new fiscal year, we are working to reduce the complexities associated with the Rockwall integration, with the by-product of this driving improved efficiencies as we streamline the process and reduce SKUs. We expect it will take some time to fully optimize our operations and we -- and then recognize the full net savings, which is our primary objective for fiscal 2018.

Turning to the Strathmore footprint consolidation. We exited the expensive coatings tolling arrangement in Houston as of the year-end and we are in the process of completing the relocation of the volume from our Syracuse, New York facility to Longview, Texas and Acworth, Georgia. This is expected to be completed by the end of June 2017.

We decided to delay this closure by 1 quarter for 2 primary reasons: First, production setup and training times for certain products have taken a little longer than expected; and second, we received some pre-buy activity ahead of these facility moves and, as a result, we believe it was prudent to leave a little extra time to ensure a seamless transition for our customers.

With that, I will turn it back over to Joe for closing remarks.

Thank you, Chris.

In closing, we are very pleased with how we finished this year and are highly focused on driving growth and profitability in all of our business segments. We have diversified our revenue base while rationalizing costs. As we look to the year ahead, we are confident in our strategy and encouraged by the trends we've been observing in our end markets and believe we are taking the right steps to deliver long-term sustainable value for our shareholders.

I'd like to take this opportunity to thank all of my colleagues here at CSW Industrials as we continue to serve our customers and steward well the capital entrusted to us by our shareholders.

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

(Operator Instructions) Our first question is from the line of Jon Tanwanteng with CJS.

Could you talk a little bit more about the Greco acquisition? Can you quantify maybe what the opportunities look like from a revenue and cross-selling synergy standpoint and if there are any potential cost saving synergies?

Yes. Let me start with that, Jon. Greco has a great line of products and it fits really well within our product portfolio. However, there are not a lot of significant cost savings here. This is a cross-selling and product extension -- product line extension acquisition and so the integration process is simple in that regard. We're not closing any facilities or integrating any production and so the opportunity really is here on the top line. And as we said, we're really pleased with the way that they have folded into our sales organization. Cross-selling is -- has begun and Greco's kind of existing legacy business, if you will, is performing very, very well in the early months here.

This is Chris. Greco has very strong relationships with architects and specifiers across Canada. And, of course, our Smoke Guard business primarily is a U.S.-based business and so combining those cross-selling efforts is really going to help us to promote Smoke Guard products in Canada and to promote the Greco products into the U.S. market, especially the West Coast. So that's part of the cross-selling is to help geographically diversify both Smoke Guard and Greco's sales.

As far as quantifying that, Jon, Greco has had kind of a historical growth rate of 9% or so and so that's a really nice growth rate. However, we're hopeful that the cross-selling opportunities will allow us to drive that even higher.

Great. That's very helpful. And just a little more color on the rail markets. What are the chances of real recovery here in the next 12 months and maybe break that down between the coatings and the lubricants side?

Sure. This is Chris. We're still not seeing much of an uptick on the railcar OEM side. And even on the refurbishment, things are still pretty slow. So for coatings, as Joe mentioned, we're still seeing a lack of recovery there.

On the lubricants side, there might be some signs for optimism. We reported in the past about the Class I railroads choosing to not lubricate the track just to save money. We're seeing a little bit of improvement there and a little bit more spend on applicator equipment, so maybe some signs of optimism on the lubricant and applicator side.

Although that's primarily with a new customer where we picked up some share gain. So the existing customers have continued to remain flat.

Got it. Okay. And just a quick update on the new CSA customers you've been adding. Are you seeing opportunities to move the margin up with those, either on new products or in how you sell into them?

Not yet.

Not yet. Those are more industrial applications, Jon, and those are going to be a little more transactional, not as highly specified as our base business. And so that's a business that's nice to have, given the current kind of weakness in the other markets, but longer-term, we want to be more heavily focused on the highly specified applications.

And on those -- this is Gregg. On those highly specified applications, as I think we've said before, those are a longer sales cycle. We are getting products out in the field for testing to be qualified. The team is working hard to drive those, but they continue to take time.

Got it. And also just wondering, how do you expect corporate expenses to trend in '18 versus '17, given all the onetimes and other things that have been going on?

Yes, Jon. This is Gregg again. We would expect them to be up probably a couple million dollars in total. That's going to be driven by a couple of different things: One, it will be driven by the fact that we had -- this will be the third year of stock awards and those vest for over 3 years so you get a full year's worth of cost with that third grant. So that's a driver. Obviously, we've added 2 new board members, that drives some costs. And there were some other savings that we saw in fiscal '17 that are not expected to repeat. Obviously, we will work hard to offset those costs within the businesses wherever possible, but it -- the corporate costs will be going up.

Okay. Got it. And then, finally, just how do you see the pipeline for further M&A valuations, the number of opportunities, all that good stuff, if you could?

Yes. Jon, we are continuing to push hard for filling the funnel with opportunities. We are absolutely committed to growing through acquisition, but doing that in a disciplined way. And so Greco was a fantastic opportunity for us, a compelling opportunity, and so we were able to get that one closed. We do have several acquisitions that we're looking at, at this time, but valuation, as you said, is always a gating item here and we've got to find the right opportunity and continue to be disciplined. So nothing to report really.

Our next question is from the line of Liam Burke with Wunderlich.

On the Jet-Lube Whitmore consolidation, it looks like the plant -- the operational piece has been consolidated. You can move along with fine-tuning or improving the operations. In terms of the sales effort and combining or cross-selling Jet-Lube and Whitmore products, how is that progressing?

Yes. I mean, Liam, this is Chris. That -- we are continuing to make progress and it's really the Whitmore and Jet-Lube and Deacon products are all being promoted by the same sales team through distribution as well as, in some cases, direct. And we've really merged those sales groups together. They work as a team. It allows us to have a broader product offering to distributors. It allows us to get into new regions where we've had some growth with lubricants and sealants in Asia and Latin America. So I think it's coming along as expected. And we've got one leader over that whole group and one sales team that's driving all those different products into the market.

And just keeping on that note, you mentioned sort of fine-tuning the SKU count now that everything's been combined. How long do you think that process will take?

This is Gregg. I think, as we mentioned, both SKU count as well as some inefficiencies, we'll continue to see some of those inefficiencies here in the first quarter. We'd like to think that most of them will be behind us. But clearly, as I think Joe and Chris both talked in our prepared remarks, we've seen the gross savings, but we have seen inefficiencies, the deal with both the SKUs as well as packaging going Whitmore. As I think you remember on your trips, Whitmore packages in very large quantities, Jet-Lube packages in small and so that's created some inefficiencies within the business all under one roof.

Sure. And then, Gregg, just a quick question on working capital. It might just be timing, but the accounts receivable balance was higher, however you want to measure it, from a year ago while the inventory level was relatively flat.

Right, right. So on the accounts receivable, 2 things. One was timing due to the strong sales within the HVAC markets within our Industrial Products. As those sales went up over 20%, that drove higher receivables. And the other factor would be the Greco acquisition. Obviously, they were not in -- their receivables were not in our balances last year and they are this year.

And then inventory, we have begun trying to work down inventory. We have a supply chain leader at each of our sites and we have supply chain leader for one of -- that oversees, our steering committee, and so that is something we're -- we've talked about this past year and we are focused on and trying to work that. We'll continue to try and drive those down.

The other thing that really didn't come out in the call that factors into some of this or in our prepared remarks is that we did see the procurement savings that we've been talking about this past year. That did roll through our financials. We saw roughly $2 million of savings here in the back half of the year and that has made its way through and so that certainly has helped our inventory levels.

(Operator Instructions) Gentlemen, there are no additional questions at this time.

Great. Well, we'd just like to say thank you, everyone, for participating in our call today. We look forward to speaking to you again soon. Thank you for your support.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.