CSW Industrials Inc (CSW) 2018 Q1 法說會逐字稿

Greetings, and welcome to the CSW Industrials, Inc., First Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Tom Cook. Please go ahead, sir.

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; Gregg Branning, Chief Financial Officer; and Christopher Mudd, Chief Operating Officer. If you've not received the earnings release, it is available on our website at www.cswindustrials.com. This call is being recorded, and 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'll 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 on 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 would now like to turn the call over to our Chairman and Chief Executive Officer, Joe Armes. Joe?

Thank you, Tom. Good morning, everyone. Thank you for joining us on our call today. I would like to begin with a few highlights from the quarter and discuss our outlook for the remainder of 2018. Then Gregg will take you through the numbers and Chris will discuss the operational highlights for the quarter.

By almost any measure, fiscal 2018 is off to a strong start with significant growth in several key metrics when compared to the prior year period. Our consolidated revenue grew 16.6% to $98 million thanks to 11% organic growth and an additional 5.6% from acquisitions. This marks the second consecutive quarter of double-digit organic growth and is a testament to the progress we've made to strengthen and diversify our sales efforts and broaden our reach to new end markets and geographies.

Consolidated revenue growth in the quarter was driven by HVAC, mining, plumbing and energy end markets. We are pleased to have achieved this level of growth despite the absence of recovery in rail, which is an important end market for us. Our reporting -- our reported operating income nearly doubled to $14.3 million compared to the prior year of $7.4 million.

On an adjusted basis, which primarily excludes restructuring and realignment costs and costs related to the CFO transition in the prior year, operating income was up 35.4% to $16.8 million compared to the prior year period of $12.4 million. We are pleased to have achieved this level of profitability, which reflects the effect of the improved efficiency, higher volume and savings from our facility rationalization programs, partially offset by an unfavorable mix in the quarter.

Major contributors to our performance in the quarter include the following: first, our Industrial Products segment continues to lead our performance. Our HVAC business performed exceptionally well as we entered the warmer summer months and our growth in this end market was 17% compared to a low to mid-single-digit growth rate for the broader end market. We attribute this outperformance to our unique product portfolio, which addresses many high-growth subsets of the market paired with our proprietary and powerful distribution platform.

More specifically, we have seen the most growth in the products that serve high-growth mini-split HVAC units. Notably, the strength in Industrial Products in the quarter came despite the absence of a major project milestone in our architecturally specified building products end market, which has been one of the leaders in our growth trajectory in recent quarters. While we continue to see a strong pipeline of opportunities in this category, the timing of project schedules was not a meaningful driver in our growth for the first quarter.

The second major driver was our Specialty Chemicals segment, where we also saw double-digit organic growth as this segment grew 24.4% over the prior quarter. The revenue growth was due to higher volume in energy and mining-related end markets that had been a notable headwind in the past as well as strong growth in the HVAC end market. We were particularly encouraged to see the earnings power of this segment when volume ticks higher, which is attributable to the consolidation of the Jet-Lube facility into our state-of-the-art Whitmore manufacturing facility, which is successfully coming down the learning curve of new production.

While we are certainly pleased with our results in the quarter, there's still plenty of work to be done to drive continued growth and efficiency. This is particularly the case in our Coatings, Sealants & Adhesives segment where volumes remain under pressure from weak railcar volume. Despite the planned consolidations of Syracuse and the Houston third-party manufacturing facility, we are experiencing inefficiencies in our manufacturing process as we move production to our Longview, Texas, and Acworth, Georgia, facilities. And those are a continued focus for us that Chris will speak to shortly.

Next, I would like to give an update on our end markets. We'll begin with the architecturally specified building products. This industry has continued to be our top-performing end market, and you should note that HVAC is not included in this end market. But as we mentioned last quarter, we're not seeing any moderation to the robust backdrop. However, given the extraordinary growth rate and the strong start to the year in 2018, we would not be surprised to see a moderation in these growth rates as the year progresses.

In our energy-related end markets in the first quarter, we began to see some meaningful volume improvement for our energy products, such as copper coat, for the first time since the decline in oil prices in late 2015. This is the result of higher rig counts, which is an important leading indicator for us that we have noted for some time. And during the quarter, we certainly benefited from the higher rig count.

With that said, we are expecting growth in the energy end market to be flat on a sequential basis. So while we will lap some earlier comparables in the coming quarters, we are not expecting a further improvement in that -- in the current environment.

Turning to our rail end market. Demand for OEM railcars remains under pressure, and we have continued our efforts to diversify our coatings, product sales and to find new markets to enter. While we are cautiously optimistic about some industry data pointing to stability and even a modest improvement in backlogs for new railcars on a sequential basis, it is simply too early to consider this a trend, and it will take some time to flow through to our business results.

We're also very encouraged by the financial performance of our most recent acquisition, Greco, as it continues to win new projects and perform above our acquisition model, which Chris will detail in his remarks.

And now I'd like to turn the call over to Gregg for a look at our financials during the quarter.

Thank you, Joe, and good morning, everyone. Consolidated revenue during the first quarter of 2018 increased 16.6% to $98 million compared to the prior year period of $84.1 million. As Joe previously mentioned, our consolidated organic growth was 11%, and acquisitions contributed 5.6% to total growth. The increase in revenue was driven by increases in HVAC, mining, plumbing and energy end markets.

As we look at our segment-level revenue and operating income, Industrial Products segment revenue was $53.3 million compared to the prior year period of $43.5 million, an increase of 22.5%. Higher revenue was mainly the result of strong sales of HVAC and plumbing end markets, coupled with acquisition-related revenue.

Organic revenue growth in the Industrial segment was 11.8%, and inorganic revenue growth was 10.7%. Operating income increased to $13.6 million compared to the prior year period of $10.6 million. Segment-adjusted operating income increased 28.9% to $13.9 million compared to the prior year period of $10.8 million, reflecting good flow-through on the increased organic revenue and strong performance by Greco.

Coatings, Sealants & Adhesives segment revenue was $23.4 million, flat compared to the prior year period of $23.4 million. Segment operating income was $1 million compared to the prior year of $1.6 million, and segment-adjusted operating income was $2.4 million compared to the prior year period of $2.6 million, which primarily excludes restructuring and realignment costs in both periods.

Specialty Chemicals segment revenue was $21.4 million compared to the prior year of $17.2 million, which was an increase of 24.4% and was all organic revenue growth. Higher sales were driven by increases in our mining, energy and HVAC end markets. Segment operating income was $1.9 million compared to the prior year period operating income of $1.1 million. Segment-adjusted operating income increased to $2.8 million or 55.6% increase compared to $1.8 million in the prior year, reflecting the sales growth and manufacturing footprint savings.

Now turning back to our consolidated results. Our consolidated gross profit increased to $42.4 million compared to the prior year level of $38.2 million. Gross margin as a percentage of sales was 43.2% compared to 45.4% in the prior year period. Lower gross margin compared to the prior year primarily reflected the effect of restructuring and realignment cost in the current period. In total, the company incurred $2.5 million in restructuring and realignment costs during the quarter, of which $2.2 million impacted gross margin.

Consolidated operating expenses decreased 8.7% to $28.1 million or 28.7% of sales compared to the prior year level of $30.8 million or 36.6% of sales. Lower operating costs compared to the prior year were primarily attributable to CFO transition and severance costs and impairment due to consolidation of facilities that did not recur, partially offset by increases relating to acquisitions.

Consolidated operating income for the first fiscal quarter of 2018 was $14.3 million or 14.6% of sales compared to $7.4 million or 8.8% of sales in the prior year. Adjusted operating income was $16.8 million, a 35.4% increase compared to the prior year period of $12.4 million.

Consolidated net income was $8.5 million or $0.54 per diluted share compared to $4.1 million or $0.26 per diluted share in the prior year period. Adjusted to exclude onetime expenses and applying a normalized tax rate, adjusted net income in the first quarter of fiscal 2018 was $10.1 million or $0.64 per diluted share compared to $8 million or $0.51 per diluted share in the prior year period.

Our net debt at quarter-end was $39.4 million, and we closed the quarter with $27.8 million of cash on our balance sheet. We had -- we have $245.3 million of borrowing capacity on a revolving credit facility, which provides us ample flexibility to fund our growth and acquisition strategy.

Now I will turn the call over to Chris.

Thanks, Gregg, and good morning to everyone. I'll start today with our Industrial Products segment as our HVAC and plumbing products enjoyed another strong first quarter. We enjoyed remarkably strong sales revenues from our innovative HVAC product lines, led by exceptional demand for key products, such as condensate cutoff switches, line-set covers and mini-split condensate pumps.

The fiscal first quarter of 2018 marked the first full quarter following the acquisition of Greco, which I'm pleased to report is progressing above our expectations in terms of revenue, profitability and integration. Acquisition and integration is an important part of our strategy. And following an acquisition, we implement a detailed integration plan that covers all the different functions involved in transitioning the acquisition into a CSWI business.

This integration plan ranges from HR to IT to procurement and finance and includes weekly meetings to monitor progress. For Greco, we were able to substantially complete this integration ahead of schedule, which has already led to enhancements in our ability to leverage these important capabilities across the business. The Greco sales team is coordinating closely with our architecturally specified building products commercial teams to maximize market penetration across the U.S. and Canada.

Moving to our Coatings, Sealants & Adhesives segment. Our integration plans have slipped to the right by a few months, and we have not yet seen the financial benefits to date. We have taken action to revise our plans to accelerate the process, and I would like to provide some detail of our 3 stages, which includes substantial progress made during the quarter.

The first step is optimizing our manufacturing operations to be positioned for long-term profitable growth. This has included the consolidation of our Syracuse facilities into Longview, Texas, and Acworth, Georgia, and we've completed this relocation in the first quarter of fiscal 2018. These actions were taken in addition to the exit from the inefficient third-party manufacturing arrangement, which were completed at the end of the last fiscal year.

Much like our experience in the consolidation of Jet-Lube into our Whitmore facility, this has included some initial production inefficiency as our team comes down the learning curve of new production. This will take some time to normalize, but using Whitmore as a proxy, we believe that we'll be able to realize the benefits at a substantially faster rate as a result of having a capable transition team and process already in place.

And in fact, we have deployed members of the Whitmore transition team to help the coatings project. It is important to note that most facility managers experience this type of facility transition, at best, only once in their career. So having refined these capabilities internally should prove to be a meaningful skill set as we progress through this reorganization.

Our second initiative within these facilities was the adoption of a new ERP system, which was completed on time and on budget in early July with no disruption to our current production output. This project has given our team enhanced visibility to manage our inventory and order flow and provides additional data analytics. These are important tools to our team leaders to further optimize our process and identify important profit levers.

As we near the completion of Phases 1 and 2, Phase 3 is focused on building new volume. As we have reported for some time, OEM railcars are the largest end market in our coatings business, which have recently shown signs of stability but at substantially lower run rates. Focusing on the factors we can control, it is important that we expand our business portfolio, gain diversification and leverage our fixed operating costs. We've made nice progress on this in fiscal 2017 through the award of contracts in propane tanks, industrial racks and energy storage tanks. In the near term, we are focused on decreasing lead times for all customers and improving segment-level efficiency. But we expect to make further progress once we have completed our restructuring.

Turning to Specialty Chemicals. I wanted to provide an update on the market success of our redesigned AC Leak Freeze applicator, which has achieved successful entry to market with strong sales. This acquisition is a nice case study for us as we acquired an excellent product formulation, which required some additional R&D to enhance the overall product effectiveness to gain a leading position. This product acquisition was a great fit for us as we leveraged our internal product engineering capability and were able to successfully redesign the applicator in about 6 months. Although we missed the main selling season last summer, this year, we're well positioned, have captured share and customer feedback has been very positive to date.

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

Thank you, Chris. In closing, we're very pleased with how we started the year, and we remain highly focused on driving growth and profitability in our business throughout the balance of fiscal 2018. We're encouraged by the top line growth we're seeing in our businesses, particularly in concert with our footprint optimization and efficient -- efficiency initiative, which together are driving improved operating results. I want to take this opportunity to thank all my colleagues at CSW Industrials for the fantastic job they're doing 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're ready to take questions.

(Operator Instructions) The first question is from Mr. Liam Burke from FBR Capital Markets.

Chris, could you give us a little more detail on the progress post consolidation of the Rockwall facility? Now that you have got the facilities combined, where are you in terms of the progress on efficiencies?

Well, our lead times are back down to normal. We have captured the savings and efficiencies that we had targeted. And as you can see, our volumes have grown nicely through sales diversification and some geographic expansion. And I think we are -- lead us to successful integration.

Liam, this is Gregg. I'll also add that, as we said from the beginning, we expect to save $5 million to $5.5 million for that consolidation. We did save $3 million last year -- last fiscal year. We expect to save the other $2 million to $2.5 million. And we captured just over $0.5 million of that $2 million to $2.5 million in the first quarter and expect that run rate to continue. We did continue to see inefficiencies as we said we would in our last quarterly call, although the good news is those inefficiencies are about half of what they were on a sequential basis coming out of fiscal Q4. And we expect to see a little bit more here in the second quarter, and then we should be in good shape.

Great. And then on CS&A, the railcar production is still on its back. You showed flat year-over-year revenue. Are you getting that much traction on the new products?

We certainly are optimistic about that, Liam, I think the challenge right now is as we go through these facility consolidations and we've had some increasing lead times as I mentioned, so right now, our focus is on getting efficiency in our Longview and Acworth facilities. And we have every reason to expect that we will then be able to capture these new opportunities shortly thereafter. So to date, it hasn't been a meaningful add to our business.

And Liam, this is Gregg, again. The big issue there is, as Chris touched on, are the lead times. The lead times, we got to get them back to what the industry expects, which is hindering our growth.

Okay. And then lastly, Gregg, inventories looked flattish on higher sales. I mean, it's tough to make a call on a 1 quarter and timing on working capital, but it looks like working capital is starting -- turns are starting to improve. And is this a trend we can look at even though it's hard to snapshot 1 quarter as a trend on your working capital turns?

Yes. Let me kind of piece that apart on working capital in total. Inventory, we certainly benefited a little, I would say, that that's more just due to the revenue growth. It is clearly, as we've talked about, focus for our organization. But it will take more time than just 1 quarter to get the significant improvement. Where we did see good improvement in the quarter was in our DPO. Our DPO was up about 4 days as we have been working hard to change terms with suppliers to become more in line with industry standards. And so I think that definitely is a step-up in the right direction and will continue. And then on receivables, as we talked before, there we continue to be mindful of what the terms are with our customers. Didn't really see a significant improvement there. Obviously, receivables went up as a result of significant sales increase.

The next question is from Jon Tanwanteng from CJS.

This is actually Mike Hagan on Jon's behalf. Wanted to focus in that HVAC segment. How sustainable is the strength that you're seeing so far?

Yes, it's a great question, Mike. It's something that we focus on as well. We feel like we have very innovative products and niche applications that have been very carefully kind of selected that we enter those submarkets and in those niche applications because of their growth opportunities. They're adoption stories oftentimes, so they grow at a faster rate than just what the install -- the installation of units. And so we think that's important. Number two, we feel like our distribution channel is a strategic advantage for us. And thirdly, I think we're doing a better job. Our people are doing a better job kind of selling those products. And so I think it's a combination of all those factors, and we're trying to really take advantage of those opportunities and the advantages that we do have. But like you, we recognize that these growth rates are pretty stretched there.

So is there any kind of concern of reaching a saturation point? Or could you use a proverbial in such inning to kind of framework...

A lot of these products are consumables.

Yes, we have consumable products. AC Leak Freeze, you use it, and it doesn't last forever. And so -- no, I think the opportunities are there. I think that we recognize that a fair amount of that innovation has been done through acquisition over the past decades, and the acquisition pipeline is important for us going forward to grow at above-market rates.

Great. Well, (inaudible) if you don't mind, I'll segue right into kind of the M&A perspective. What are you seeing in terms of valuation? What are you seeing in terms of quantity/quality of deals? Are they improving? And then maybe any color on kind of what end markets particularly look attractive.

Yes. We have not really seen any change in the market. We continue to feel like valuations are high. Opportunities, good companies come to market. They're often intermediated, and there's a lot of competition for them. And so we are highly focused on acquisition growth. As you can see from this quarter, acquisition growth was an important piece of our growth. Roughly, 1/3 of our growth this quarter is from acquisition. And so that's an important component of our growth story going forward. However, we believe that ultimately discipline will be rewarded, and we're just not going to overpay. And so that's where we find ourselves. We are redoubling our efforts with respect to filling the funnel and making sure that we see opportunities. I'm personally taking a fair amount of time and attention in that regard, and we think that will pay off ultimately. But it's a frothy market today, and we are kind of committed to a disciplined approach.

Sure. Fully understood, Joe. One last thing. With regards to the increases we saw in Specialty Chem and kind of tying into the comment made towards the end of the -- your guys scripted comments about how you missed last summer selling season, but this summer you should capture some share. Should we expect to see kind of sequential increases? And then what would also be -- if you could provide any guidance on margin impact? And then finally, is it concurrent with rig counts? Is it delayed from rig -- is there a lag to rig counts? If you could just help me a little bit on that.

Yes. Number one, we expect the rig count we're -- we're assuming the rig count is flat. And so we don't see sequential -- continued sequential increases in the rig count like we've seen over the last 12 months. And a fair amount, a good portion of our Specialty Chemicals sales growth this quarter is related to energy. So that's -- and the comment about the selling season last year and innovation on the AC Leak Freeze this year, and that's an important new product, but it's relatively -- it's much smaller than our energy end market that -- because that's just one product. So we feel like margins as volume increases, margins can expand. But we're committed to growing that business and diversifying. I would say, in Specialty Chem, another positive influence there on our growth has been new geographies. And so there's some international sales that have been increasing there, and a weaker dollar is probably helping us there a little bit. And so there's a number of factors going into that huge increase in Specialty Chemical sales.

Mike, this is Chris. One other comment on HVAC. It covers multiple reporting segments. So we got the chemicals like the AC Leak Freeze products but also probably the majority of our HVAC would be in the industrial products segment. And Q1 is the strongest quarter historically, followed by Q2. But HVAC typically, you get off to a strong start at the beginning of a hot summer.

Mike, this is Gregg. The other thing I would add is that looking at the end markets for Spec Chem in total in the aggregate versus on a specific end-market basis, as you think of the different aspects and the fact that rig count, as Joe said, we expect, can be flat, and as Chris said, you can take HVAC and the seasonality impact, from a sequential standpoint, we wouldn't expect really any significant improvement. What is important to note is Q2 actuals last year coming off of a fair low comp. So I wouldn't expect a whole lot of growth from a sequential standpoint, but we expect to continue to hold the share that we've had.

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Mr. Joseph Armes for closing remarks. Please go ahead, sir.

Yes. We just want to say thank you. We really appreciate everyone participating today and appreciate your interest in CSW Industrials and look forward to speaking to you next quarter. Thank you.

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