CSW Industrials Inc (CSW) 2018 Q2 法說會逐字稿

Greetings, and welcome to CSW Industrials' Second Quarter Fiscal 2018 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to turn the conference over to Tom Cook with ICR. Mr. Cook, you may now begin.

Thank you, Rob. Good morning, everyone, and welcome to CSW Industrials' Fiscal Second 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 more complete discussion of adjusted operating income, net income and earnings per share, see our earnings release.

I'd 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 the call today. I'd like to begin our call with a few highlights from the quarter and give an update on our end markets. Then Gregg will take you through the numbers and Chris will discuss the operational highlights for the quarter.

We're pleased to report that we've continued to build on the momentum of the first quarter and delivered another strong quarter of growth in fiscal Q2 of 2018. This was despite a difficult backdrop for many of our colleagues who were located in Southeast Texas and were adversely affected by Hurricane Harvey. We're very grateful that none of our team members were seriously injured during the storm, although several did experience property damage. Our company quickly pulled together to provide assistance, and we launched a GoFundMe site to help support our affected employees which received contributions from folks associated with our company and externally. So I want to thank everyone for their support and thank our team for their dedication to their colleagues and to our business during this time.

As a company, we were fortunate that our facilities were not damaged by the storm. While we did lose some shipping days at our RectorSeal facility and experienced some logistical challenges in Texas and Florida, the overall impact of Hurricanes Harvey and Irma to our consolidated results was limited to $2.6 million of estimated lost sales. Despite this, we were still able to post double-digit revenue growth for the quarter.

Turning to our financial results for the quarter. We continued to demonstrate strong performance in Industrial Products and notable improvement in Specialty Chemicals, which together drove consolidated revenue growth of 12.8% to $90.4 million. In spite of the hurricanes, organic growth was 6% during the period and acquisitions contributed 6.8% of total growth.

Our reported operating income increased 72.4% to $12 million compared to the prior year of $6.9 million. On an adjusted basis, which primarily excludes restructuring and realignment in both periods and an asset impairment charge in the prior year, operating income increased 22.9% to $14.1 million.

Higher profit was driven by higher total revenue and efficiency gains in our Industrial Products and Coatings, Sealants & Adhesives segments, partially offset by a negative mix.

Next, I'd like to provide you with the highlights in each of our segments.

Beginning with Industrial Products. As you know, we've generated very strong growth in this segment over the past few years, and the second quarter was no exception with top line growth of 15.8%. Strength this quarter stemmed from our HVAC business, as would be expected during the warm summer months. And we saw a strong demand for line-set covers and condensate switches during the period.

In our architecturally-specified building products, we're continuing our sales integration efforts, particularly between Smoke Guard and Greco. And those efforts are yielding compelling results. Chris will provide more details in a moment. But our goal is to leverage the sales team to yield a higher quantity of bids for more of our products. Our win rate on these types of products is fairly stable over time, and a higher volume of total bids provides the opportunity to drive above-market growth in revenue as well as our future project pipeline.

Turning to our Specialty Chemicals segment. Year-over-year, sales growth was 34.6% as volume in our energy-related end markets continued to surge from overall higher drilling activity. We also saw a sizable pickup in activity for products serving international mining operations, particularly for minerals in Latin America. Following the completion of our Jet-Lube, Whitmore facility consolidation, we've successfully eliminated the manufacturing inefficiencies experienced early in the process. And I'm pleased to report that our product quality, scrap and lead times have returned to normalized ranges. We've utilized the experience of the Whitmore, Jet-Lube facility integration as an internal case study. We are actively deploying lessons learned to our other operations teams. Chris will detail this in his remarks in a moment. But from a strategic standpoint, communicating these learnings across our internal teams and enhancing our capabilities will improve our likelihood of success when executing on our long-term acquisition strategy.

Turning to Coatings, Sealants & Adhesives. Volume remains challenged in this segment as sales declined 7.1% during the period, which reflect challenged end markets and the temporary effects of our capacity consolidation projects. We have completed the consolidation of our Syracuse, New York manufacturing facilities and Acworth, Georgia and Longview, Texas facilities. We are currently working through production inefficiencies much like we experienced with the Jet-Lube, Whitmore integration. These challenges aside, I am pleased that our segment level margins have improved over the prior year as a result of favorable mix, combined with a lower fixed cost structure.

Next, I would like to give an update on our end markets. Beginning with our construction-related end markets, we're off to a great start in fiscal 2018, which we expect to continue through the end of the fiscal year. We follow several different indices in the commercial construction end market, and those third-party sources suggest that strength will continue into calendar year 2019. As we think about the cycle, it's important to remember that our -- in our architecturally-specified building products, many of our products are installed closer to the end than the beginning of the projects. So we typically have good forward visibility into this business.

In HVAC, we continue to see strong growth in our unique products that support both traditional HVAC and the fast-growing mini-split HVAC markets.

While the hurricane rebuilding activities in Southeast Texas and Florida in the coming quarters will, no doubt, drive an uptick to overall building activity, we do not anticipate a noticeable effect, as many as our HVAC products are located in the attic of homes and avoided the effects of the storm in many cases.

Turning to our energy-related end markets. Drilling activity continues to be stable, as we predicted, over the past few quarters. Specific to our business, we are lapping weak comparable quarters due to delayed shipments in Q2 of fiscal 2017, during the most challenging period of our Jet-Lube, Whitmore integration. And that has aided our growth rate in fiscal -- Q2 2018 over the same quarter in 2017.

In our rail end markets, OEM volume appears to be bottoming and trends are flat year-over-year. In discussions with our customers, we have heard some indications of a modest uptick in calendar 2018. But it is too early for us to make any kind of call here. In our rail lubricants, the domestic Class 1 rail operators have been under pressure to reduce costs and defer maintenance despite a backdrop of improving rail traffic. This puts pressure on our growth rate in the short term, but it also adds long-term implications. We believe that track maintenance requirements will ultimately smooth out any impact to our results over the longer term.

So we're very pleased with the results through the first half, as we've maintained focus on driving growth and profitability across our segments. We are encouraged by the top line growth we're seeing in our businesses, particularly as our capacity optimization and efficiency initiatives drive improved operating results. And recently, we were very pleased to have been honored as one of the region's fastest-growing public companies by the Dallas Business Journal.

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

Thanks, Joe, and good morning, everyone. Our consolidated revenue during the first -- during the fiscal second quarter of 2018 increased 12.8% to $90.4 million compared to the prior year period of $80.1 million. Our consolidated organic growth was 6% and acquisitions contributed 6.8% to total growth. The increase in revenue was driven primarily by higher volume in our energy and HVAC end markets as well as $5.4 million in acquisition-related revenue. This was partially offset by $2.6 million of estimated lost sales from the effects of Hurricanes Harvey and Irma, as Joe commented earlier.

Turning to our segment level revenue and operating income. Industrial Products segment revenue was $48.5 million compared to the prior year of $41.9 million. Higher revenue was primarily the result of strong sales into HVAC, coupled with $5.4 million of acquisition-related revenue from Greco.

Operating income increased to $12.3 million compared to the prior year of $9.9 million. And segment adjusted operating income increased 26% to $12.5 million compared to $9.9 million in the prior year. It was driven by increased sales in operating income from our Greco acquisition of $1.4 million.

Coatings, Sealants & Adhesives segment revenue decreased to $21.4 million compared to the prior year of $23 million, due to shipping delays associated with the Strathmore footprint consolidation project and continued softness in the rail end markets. Segment operating income was $0.3 million compared to the prior year operating loss of $1.6 million. Segment adjusted operating income was $2.2 million, which was approximately flat when compared to the prior year period.

In our Specialty Chemicals segment, revenue increased 34.6% to $20.5 million, which was all organic, compared to the prior year of $15.2 million. The increase was the result of our energy market as -- was the result of our energy end markets improving as rigs counts have continued to rise. The segment operating income for Specialty Chemicals was $2.2 million compared to the prior year period operating income of $1.2 million. Adjusted operating income increased to $2.2 million compared to $1.7 million in the prior year, reflecting the sales growth and manufacturing footprint savings, and was partially offset by negative mix.

As we move back to our consolidated results, our consolidated gross profit increased to $38.8 million compared to the prior year level of $35.7 million. Gross margin as a percentage of sales was 43% compared to 44.5% in the prior year. The lower gross margin compared to the prior year primarily reflected the effects of restructuring and realignment costs as well as some negative mix. In total, the company incurred $2 million in restructuring and realignment costs in fiscal Q2 2018.

Our consolidated operating expenses decreased 6.5% to $26.8 million or 29.7% of sales compared to the prior year level of $28.7 million or 35.8% of sales. The lower operating costs compared to the prior year mainly resulted from a one-time impairment of intangible assets, which did not recur.

Consolidated operating income for the fiscal second quarter 2018 was $12 million or 13.3% of sales compared with $7 million or 8.7% of sales in the prior year. Adjusted operating income increased 22.9% to $14.1 million or 15.7% of sales compared to the prior year period of $11.5 million or 14.4% of sales.

Our consolidated net income was $7.3 million or $0.46 per diluted share compared to $3.8 million or $0.24 per diluted share in the prior year period. Adjusted to exclude onetime expenses and applying a normalized tax rate, adjusted net income in the second quarter of 2018 was $8.9 million, up 18.7% or $0.56 per diluted share compared to $7.5 million or $0.48 per diluted share in the prior year period.

Our net debt at quarter end was $24.8 million. And we closed the quarter with $28.4 million of cash on our balance sheet and had $246.8 million of borrowing capacity on our revolving credit facility, which provides ample flexibility to fund our organic growth and acquisition strategy.

Now I'll hand the call over to Chris.

Thanks, Gregg, and good morning to everyone. As Joe and Gregg have highlighted, our results through the first half of our fiscal year have been very strong, in part thanks to the maturing of several of our operational initiatives we've implemented across our businesses. I'd like to spend our time today providing an update on these initiatives. And I'll begin with our internal acquisition integration capabilities.

Since our commencement as an independent public company, we have been building and continuously refining our integration capabilities. I'm pleased to report that our recent acquisition of Greco has been one of our strongest inorganic performers in the first year of ownership, with success attributable in part to a stronger set of integration tools that we've developed over the past few years, particularly around our sales integration efforts. As you may recall, we restructured our architecturally-specified building products sales team, and through joint marketing efforts with Smoke Guard, we've seen very compelling results.

In the second quarter, our Smoke Guard sales coordination efforts directly led to nearly $1 million in incremental Greco quotes. As another highlight from the quarter, Greco was selected to supply exterior glass railings for Toronto's newest high-rise residential towers on the shores of Lake Ontario, the Eau du Soleil Condos. This massive project includes more than 10 miles of railings and marks the largest award in Greco's history, and it showcases the breadth in -- of capacity and sophistication of this business. Notably, the design of the buildings includes 2 separate aluminum railing cosmetic features, dubbed the swoosh, one of which will be on the 46th story tower and another on the 66th story tower, which Greco will also be providing. One of Greco's core competencies to win large-scale contracts is its ability to supply product on a short lead times, which results from its application of Lean Six Sigma manufacturing techniques.

To share best practices, we held an operation summit in the quarter with other CSWI manufacturing leaders in Windsor, Ontario. And that is expected to lead to the implementation of several best practices across our organization. It's exciting to see Greco, our newest acquisition, making key financial and operational contributions to the organization as well as learning from the rest of the CSWI operations leaders.

Turning to our efficiency improvement efforts and our footprint consolidations. As the integration of Jet-Lube and Whitmore facilities were completed at the end of fiscal 2017 and we corrected the related operational inefficiencies, we learned some valuable lessons and identified a set of best practices for this important function long-term, as we continue to pursue our growth strategy through acquisition. In the spirit of this, we have shared best practices and resources from our Jet-Lube, Whitmore integration, which we have now deployed into our Strathmore consolidation project. Currently, we've ceased manufacturing in our Syracuse, New York and Houston third-party manufacturing facilities. And during the quarter, we saw notable improvements in our lead time in our Longview, Texas and Acworth, Georgia facilities.

Lastly, I'd like to discuss some of our product development and organic growth plans as we've redoubled our efforts in this area. As you know, CSWI has strong internal product development capabilities that have led to notable market successes with selective, focused R&D investments like our large screen smoke curtains that we brought to market in fiscal 2016 by the Smoke Guard team. Another more recent example is through our product enhancements with AC Leak Freeze PRO, which was initially an acquired product with superior sealant chemistry which we paired with an internally-designed innovative applicator that has led to strong success of that product during this air conditioning season. As valuations in the M&A pipeline remain elevated and are often outside the range of the disciplined set of metrics that we apply towards valuations, we are selectively identifying products already within the CSWI family that can be developed or improved to drive incremental organic growth. This initiative is not expected to have a material impact on our overall R&D spend and is likely to involve a wide range of products across our businesses. But we believe, based on our recent experience in other areas, this could drive a meaningful impact to organic growth. For competitive reasons, it's a little early for us to cite any specific projects that we've begun, but I'm excited about our internally-generated pipeline that our teams are currently working on.

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

Great. Thanks, Chris. I'd just like to say in closing that at the halfway point in fiscal 2018, we are very pleased with the progress we've made, particularly as our internal initiatives to drive performance have begun to be reflected in our results. These improvements are supported by a generally positive macro backdrop across the end markets we serve, which positions us well to focus on execution and drive shareholder value. Let me take this opportunity to thank all of my colleagues 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.

And Operator, we're now ready to take questions.

(Operator Instructions) Our first question is from the line of Liam Burke with B. Riley FBR.

Joe, the architectural business is typically pretty variable from quarter-to-quarter based on the project nature. Could you give us a sense on how it did outside as a stand-alone revenue contributor this quarter?

Yes. Revenue was relatively flat, but that was against our -- some really strong quarters last year. And so I would say that the business overall is very, very healthy. I think the variability is going to decline as we have added new products. And so we have added the Greco business to that. And so very, very pleased with the performance there.

Great. And on the margin front, I know that Gregg highlighted the incremental revenue contribution from Greco. You had a nice operating margin step-up year-over-year. That wasn't entirely Greco. Was it something else in there?

Liam, this is Gregg. Greco contributed about $1.4 million of the increased margins. The rest of it was simply the leverage on the higher sales that we saw within Industrial Products.

Great. And lastly, on the R&D front. It looks like that you've got a nice product pipeline. Chris, you highlighted the fact that you can get these new products without significantly increasing your R&D. Do I understand that right?

Yes. I mean, it's really a matter, Liam, of just prioritizing and focusing our R&D resources on the right things. And so what we've really done is prioritized organically -- internally developed products and product enhancements over and above sort of any kind of really blue sky, step-out activities that they might be working on. So we've got a number of things that we're excited about that are in the pipeline that will be coming into the market in the future. And we're able to do that with the existing resources we've got, and it's simply a matter of just prioritizing and focusing on the right things.

Yes, this is Gregg. I would echo what Chris said. We're not expecting and I wouldn't factor in really any increase in cost per se. It's just reallocating resources to focus their priorities where it's going to best suit us.

At this time, I'll turn the floor back to Joe Armes for further remarks.

Great. Again, thank you for joining us on the call today. Really appreciate your interest. And we look forward to visiting with you again next quarter. Thank you.

Thank you. This will conclude today's conference. You may disconnect your lines at this time. And have a wonderful day.