CSW Industrials Inc (CSW) 2018 Q4 法說會逐字稿

Greetings and welcome to the CSW Industrials fourth-quarter 2018 earnings 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, investor relations for CSW Industrials. Thank you. You may begin.

Thank you, Melissa. 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, and Gregg Branning, Chief Financial 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 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 would now like to turn the call over to our Chairman and Chief Executive Officer, Joe Armes. Joe?

Thank you, Tom. Good morning and thank you, everyone, for joining our fiscal fourth-quarter conference call. We had a solid finish to fiscal 2018 with our fourth-quarter results, which was highlighted by growth across both of our segments. And a 17.6% improvement in adjusted earnings from continuing operations.

At a consolidated level, sales grew 9.2% to $83.5 million, with organic growth driving over two-thirds of that improvement. Adjusted earnings from continuing operations were $8 million compared to $6.8 million in 2017 and reflect strong operating results, the benefit of our restructuring and realignment efforts in prior periods, and the benefit of lower taxes associated with recent legislation.

Moving to our segment results and beginning with industrial products, we finished the year on a very strong note, with sales growth of 12.5% to $46.8 million, driven by higher organic volume of 7.7% and contributions from the acquired Greco business of $2 million.

In our HVAC business, volume continued to be very strong, which included higher overall demand for mini-split products such as line set covers, condensate cutoff switches, and pumps, which we have spoken about in the past.

In our architecturally specified building products, Greco has been a very successful acquisition and a good case study for us. We have been able to deliver sales above our expectations, as their sales are up 31.1% from the trailing 12 months prior to our acquisition through leveraging our broader sales force, successfully exploiting cross-selling opportunities, and offering unique products. Operationally, our integration team has executed well to weave this business into our existing platform.

Looking ahead, we are delivering product on the Eau Du Soleil project, our pipeline of new projects remain strong, and our integration with the Smoke Guard sales efforts is progressing exceptionally well. In fact, I am pleased to report that we are seeing a notable uptick in joint bidding projects and our teams are leveraging complementary projects and geographies of those two discrete business units.

Turning to our specialty chemicals segment, sales in the fourth quarter were $36.6 million, which was an increase of 5.2% compared to the prior year. Higher sales were driven by higher volume of plumbing and energy-related products, partially offset by lower mining and rail-related products.

Segment level adjusted operating margin was $3.5 million or 9.6% of sales compared to $4.2 million or 12.1% of sales in the prior year, primarily as a result of negative product mix during the period and some discrete costs that we do not expect to repeat.

We are refining our operations to improve the profitability of energy-related products. As an example, during the fourth quarter, we commenced 24-hour, 7-day-a-week operations at our Rockwall, Texas, facility, which has enabled us to bring small fill products from the Jet-Lube integration in-house.

These smaller packaged products typically carry a higher cost of production. And we have been working to strike the right balance between reducing manufacturing costs and strategic pricing. On the cost side, in-sourcing these products improves asset utilization and improves product margin.

Next, I'd like to touch on our capital allocation initiatives. We are in the envious position of having minimal debt and strong cash flow available to fund our organic and inorganic growth plans that will enable us to maximize shareholder value.

During the quarter, we repatriated $19.5 million in cash, which bolsters our cash reserves as it allowed us to pay down the majority of our debt outstanding under our revolver. And we remain active in pursuing strategic bolt-on acquisitions.

As we have stated in the past, valuations remain elevated and our disciplined approach to risk-adjusted return parameters has limited our activity over the past few quarters. While we have been and will remain disciplined on M&A, we have added resources and efforts to increase the volume of opportunities that we review.

With that as a backdrop, we have refocused our efforts internally as margin enhancement investments, the expansion of our international sales force, and internal product development projects point to more favorable returns. This has included activities to enhance our efficiency by bringing additional production in-house to drive higher asset utilization and targeted sales personnel additions in key international locations, coupled with redeployment of resources to fund R&D for future organic growth.

In addition, we have been executing on our share repurchase program, purchasing 25,000 shares in the fourth quarter. And we have increased this activity to date in fiscal 2019. We continue to evaluate additional ways to return cash to shareholders, given the strong cash generation that we are anticipating.

Next, I would like to give an update on our end markets. Beginning with HVAC, we have enjoyed strong growth throughout fiscal 2018. Our HVAC condensate cutoff switches have performed well throughout the year, as we have seen robust residential new home growth compared to the prior year.

Importantly, we are continuing to see strong demand from replacement systems, driven by the aging of systems installed at the peak of housing construction in the early 2000s. As a result of the aging installed base, we expect this to be an area of sustained demand for our HVAC products.

In our architecturally specified building products, we have continued to enjoy a strong commercial construction backdrop, with an acceleration to mid-single-digit growth in nonresidential construction expected through 2019. Beyond the health of the broader end market, the outlook for this business is dependent upon our project pipeline, which points to additional growth as we head into fiscal 2019.

Turning to plumbing, we are seeing robust growth for our broad-based portfolio of products, driven by our unique offerings and our strong distribution channels. In our energy-related end markets, rig count continues to grow, which has led to improving demand for Jet-Lube products.

Finally, with mining, we have observed very strong growth in international markets, where we have added sales resources, which has served to offset continued weakness domestically. Mining in total represents a very small portion of our overall end market mix, but we are pleased to be able to offset the domestic decline with a small but rapidly growing international business that positions us to resume end market growth in 2019.

Before turning the call over to Gregg, I would also take a moment to provide an update on our coatings business divestiture. Since we moved this business to discontinued operations last quarter, we have been diligently working to identify the appropriate long-term owner of this business.

While we are still relatively early in the process, I am pleased to report that we have interest from multiple prospective strategic buyers which can leverage these industry-leading brands. And we look forward to providing additional information as soon as practical.

Our results for fiscal 2018 underscore our commitment to driving long-term shareholder value. Our revenue and profitability continue to improve as we expand our sales into new geographic areas while also diversifying our product offerings through proprietary and high-end high-value-add products.

We continue to generate strong free cash flow by driving organic growth, optimizing our production facilities, and identifying synergies, which in turn will allow us to fund our inorganic growth strategy. I'm pleased with the work that we have done throughout fiscal 2018 and believe we are well positioned to drive increased value in the year ahead.

Now with that, I will turn the call over to Gregg to take a closer look at our financials.

Thank you, Joe, and good morning everyone. Consolidated revenue during the fourth quarter of 2018 increased 9.2% to $83.5 million. Our organic growth was 6.6% and acquisitions from our Greco business contributed 2.6% of the total growth.

The higher revenue was mainly the result of strong sales in HVAC and plumbing end markets and sales from the acquired Greco business, which was $2 million, partially offset by decreased volumes in our legacy architecturally specified building products.

Looking at our segment level revenue and operating income, industrial products segment revenue was $46.8 million, which was up 12.5%. The increased revenue was mainly the result of strong sales in HVAC and plumbing end markets and sales from the acquired Greco business, partially offset by decreased volumes of our legacy architecturally specified building products.

I will remind everyone on the call that we acquired Greco on February 28, 2017, so the inorganic sales for Greco that I mentioned previously in the comparison were for the two months of our fiscal fourth quarter 2018.

Reported segment operating income increased 28.6% to $10.8 million, while adjusted segment operating income increased 13.5% to $10.9 million. Segment adjusted operating income as a percentage of sales improved 30 basis points to 23.3%, primarily driven by the increased sales volumes.

Specialty chemicals segment revenue increased 5.2% to $36.6 million. The increased sales were primarily driven by higher volume of plumbing and energy-related products, partially offset by lower mining and rail products.

Our reported segment operating income was $3.3 million compared to the prior-year period operating income of $799,000. Adjusted to exclude nonrecurring costs, segment operating income decreased to $3.5 million compared to $4.2 million in the prior year.

The segment adjusted operating income as a percentage of sales was 9.6% compared to the prior-year period of 12.1%. And this decrease was primarily due to the unfavorable product mix that we've seen throughout the year and some discrete costs in the fourth quarter that are not expected to repeat.

Turning to our consolidated results, consolidated gross profit in the fourth quarter of 2018 grew 18.7% to $36.2 million. Gross margin as a percentage of sales was 43.4% compared to 39.9% in the prior-year period. Higher gross margin compared to the prior year primarily reflected increased operating leverage on our higher sales and lower restructuring and realignment costs, partially offset by unfavorable mix in our specialty chemicals business.

Consolidated operating expenses increased to $25.7 million or 30.7% of sales compared to the prior-year level of $24.1 million or 31.5% of sales. The increase in operating expenses was due to increased revenue and expenses from the acquired Greco business, partially offset by lower one-time discrete expenses year over year. As a percentage of sales, we were pleased with the 80-basis-point improvement in operating expenses year over year.

Consolidated operating income for the fourth quarter was $10.6 million or 12.7% of sales compared to $6.4 million or 8.4% of sales from the prior year. The adjusted operating income was $11.4 million, a 3.6% increase compared to the prior-year period of $11 million.

The effective tax rate on continuing operations for the quarter ended March 31, 2018, was a negative 6.8%. The tax benefit was the result of the refinement of the one-time transition tax for mandatory repatriation based on cash and net accumulated earnings and profits of our foreign subsidiaries due to the US tax reform legislation passed in the fourth quarter. Our fiscal 2019 effective tax rate is expected to be in the range of 25% to 27%, as we have stated on previous calls.

Consolidated earnings from continuing operations was $10.6 million or $0.68 per diluted share compared to $3.3 million or $0.21 per diluted share in fiscal 2017. Adjusted to exclude one-time expenses and applying a normalized tax rate, adjusted earnings in the fourth quarter of fiscal 2018 was up 17.6% to $8 million or $0.51 per diluted share compared to $6.8 million or $0.42 per diluted share in the prior period.

Our operating cash flow from continuing operations increased 45.7% to $57.4 million in fiscal 2018. The increase was primarily driven by increased profits, improved working capital management, and lower taxes. We expect cash flow from continuing operations to be further enhanced in fiscal 2019 as a result of the lower domestic tax rates and as we continue to drive operational efficiency and working capital management.

Our net debt at quarter end was $12.3 million and we closed the quarter with $11.7 million of cash on our balance sheet and have $288 million of borrowing capacity on our revolving credit facility, which provides us ample flexibility to fund our growth and acquisition strategy.

With that, I will turn the call back to Joe.

Thanks, Gregg. In closing, we are very pleased with how we finished the year. We are highly focused on driving growth and profitability in both of our business segments in fiscal 2019. As we look to the year ahead, we expect to continue our progress and building a great company. And we also expect to deliver long-term sustainable value for our shareholders.

I want to take this opportunity to thank all my colleagues at CSW Industrials who do such a great job every day as we continue to serve our customers and also as we steward well the capital entrusted to us by you, our shareholders. Thank you for your interest in CSW Industrials today.

Operator, we are now ready to take questions.

(Operator Instructions) Jon Tanwanteng, CJS Securities.

Good morning, gentlemen. Nice quarter. Thanks for taking my questions. Joe, a quick one on the organic growth: 7%. It's been pretty consistently good for you guys. How sustainable do you think that is, given where end markets are heading?

And you gave comment on HVAC. What about energy? And maybe if mining or rail may come back in the near future at all?

Yes, you know, Jon, we say it over and over. But the good news and the bad news here is that we are broadly diversified in our product portfolio and in our end markets. And so we are typically going to have one or two end markets that are really hot, one or two end markets that are struggling, and two or three in the middle somewhere and it's just our job to manage through it.

I feel that our current organic growth rate is sustainable. There are things like this cycle with respect to replacement and repair on the HVAC installed base, huge number of residential construction that was done back in the early 2000s that is now coming up for repair, replacement. We think that is an important cycle that is going to drive the sale of our HVAC products.

Energy -- rig count has leveled off a little bit here, but remains strong. I think that given our small market penetration in a number of markets that we can continue to drive well above GDP organic growth. And that is certainly our goal and our commitment.

Jon, this is Gregg. The other thing I would add is that on the HVAC where we've had the sustained growth and expect to continue to see that growth, as Joe mentioned, that replacement cycle that Joe talked about, typically those units last 10 to 15 years.

So the cycle that Joe mentioned in the early 2000s, those are all coming due. And we have always said that we have a strong MRO business and that continues to be strong, driving future growth as units come out of service and get replaced.

Got it. That's all very helpful. Gregg, in the specialty chemical segment, you went on a little bit on the operating margins. But I'm just wondering: what were these specific drivers that took the margin down both year over year and sequentially? And how should we think of them going forward? What are the steps you are taking to improve it?

Yes, so we had some discrete costs that we mentioned in the fourth quarter. We didn't call them out or adjust them out, but they were, we believe, one-time. We had some write-offs for some receivables and then we also had some employee benefit costs. The total of those were around $700,000 in the quarter and so I think that was the biggest impact.

We continue to see the negative product mix that we've seen throughout the year as we continue to have strong energy-related product sales. We are working hard, as Joe mentioned in our prepared remarks, to improve that, increase our asset utilization there, and continue to work to become more efficient in specialty chemical.

Okay, great. And then Joe, finally, you mentioned increasing your national sales effort. Some are indeed being accelerated, and also you are adding assets or resources to M&A. How does that flow through to the corporate costs or the SG&A? How should we think about [things] going forward, given those items?

Yes, the M&A piece will not be a significant increase in cost, and the sales and R&D will all be at the segment level and will run through their P&L. Again, on the R&D, a lot of it is just human resource, time, effort, attention, focus. We have not spent a lot of money there and probably won't need to spend a lot of money there.

It's really focus and making sure that the right people are working on the right projects that are the highest commercial value and having a real process with respect to driving that process forward.

And then sales -- again, some of these are our own employees that we are adding in other geographies. Sometimes we are changing distributors, sometimes we are adding sales reps. And so it's a bit of a mixed bag with respect to how those might hit the income statement. But I wouldn't expect to see any diminution of margins as a result. We think all those investments will pay for themselves.

Yes, and Jon, this is Gregg. I would add a little bit of color. When we look at our operating expenses for fiscal 2019, we do expect them to tick up due to some of the costs that Joe mentioned.

I think we are going to be in the range of somewhere between 29% and 31% OpEx as a Company. The biggest driver in there is actually going to be some of our corporate costs, where that will tick up somewhere between $1 million and $2 million.

And that's primarily the result of our higher share price. You may recall in prior discussions where the share price drives the performance share award. So as the stock price goes up, the cost for that goes up and so that will create some of that uptick. But we continue to manage our base cost very effectively.

Got it. That's all very helpful. Finally, just any quick thoughts on -- you mentioned that there's multiple suitors or potential buyers for the coatings business. When is the soonest that you think a transaction could happen and you could announce something there?

Yes, we're going to be careful about that, Jon. Obviously, we have a December 31 drop-dead date and we think we will be well earlier than that. And beyond that, obviously, we are just limited in what we can say, but we are working really hard on it.

We are very pleased with the progress, very pleased with the attention and the interest, and very pleased with the list of parties showing an interest. It's a high-quality group of strategic buyers and we are very pleased.

Okay, great. Thank you so much, guys.

(Operator Instructions) Liam Burke, B. Riley & Company.

Thank you. Good morning, Joe; good morning, Gregg. Joe, you mentioned organically the architectural business was down for the quarter. It is project-based. You've got strong end markets and you touched on 2019 as you would expect that business to be up. It's just a function of your visibility or your confidence in the end markets or both?

Really both. I would say that 2018, we did have some big projects that didn't repeat. We did have a couple of execution issues out there that we think we have gotten solved. And we do have visibility with respect to bids and bookings and there has been a fair amount of analytics done around that with respect to if we bid X number of projects, how many should we expect to get.

And so we feel like we've got a pretty good handle on 2019. Unlike some of our other business, which are clearly customers just call and buy the product and we ship it next day, the architecturally specified building products business does have a longer lead time and more visibility. So that's part of the good news there.

But yes, it's all the above. The market is still strong. Again, we are looking at a lot of projects and our visibility is good. And then the last thing I would say is it really seems that the cross-selling and the synergies between Greco and Smoke Guard in particular and to a little lesser extent Balco and even some of the fire-stopping products that RectorSeal sells, all of those are being marketed together now. And we are seeing some benefit from that.

And Liam, this is Gregg. The other thing I would add is that in that legacy business, our backlog has ticked up, which is a precursor for 2019. So while Joe mentioned we had some execution issues in fiscal 2018, we watch the backlog and bookings very closely and the team has done a nice job, as Joe mentioned, on the analytics so that we can have a good feel for what's going to happen there.

Great. Gregg, working capital, however you want to define it, the performance year over year was very strong in terms of metrics at both the current asset and current liability side. Is that a function of pulling Strathmore out of the mix or have you actively managed it? Or what has driven those improved turns?

Yes, good question. I think it's a little of both. Clearly when you look at the working capital year over year, Strathmore is out of both sets of numbers. So it's a clean number from that standpoint.

Obviously, prior to us putting Strathmore into disc ops, working capital was an issue for Strathmore. But on the base business, because everything is on a continuing ops, both on the balance sheet and in our cash flow statement, that's a clean working capital.

And as we've said for over a year now, we focused very heavily on working capital and we will continue to focus on it. In fact, in fiscal 2019, operating cash flow will become a metric in our annual incentive program for everyone. And so it's not just going to be based on earnings; it will also be on the operating cash flow to properly align everyone's interest and further drive that.

Good. And I apologize if you mentioned it or if there is no change. Did you mention the tax rate that you would expect to be running at now?

Yes, we would expect our tax rate to -- the effective tax rate to be between 25% and 27%. In the fourth quarter on an adjusted basis, we had 26.5%. And as I have said on prior calls, that's driven by various discrete aspects of the new tax bill, such as compensation, the lower tax shield from a federal perspective, and the continued taxes now on foreign earnings that previously didn't exist.

Great. Thank you, Joe. Thank you, Gregg.

Joe Mondillo, Sidoti & Company.

Good morning. So I apologize; I missed the very beginning of the call, so if I ask anything in repeat, I apologize in advance. But I just want to ask, the revenue growth at the industrial segment was a little stronger than I was anticipating, primarily just given the weather and my expectation that maybe that HVAC business would have suffered a little bit.

So I am just wondering if you could comment on that. And does that sort of indicate to us that that business is even stronger than maybe the numbers actually even tell, just given that maybe weather did weigh on growth a little bit?

Yes, Joe, this is Joe. I think that we firmly believe that the fourth quarter was very strong in that industrial products because of the preseason stock-up sales to HVAC distributors. And so as we've said all along for several years now, the month of March is a big, huge driver for the way our year ends up.

And so what we saw was very, very strong preseason stocking orders from our customers, large customers in particular. But we agree; that was in the face of some pretty cool spring weather. And we were very pleasantly kind of -- we were very pleased with the result.

Now, since that time, we've got to keep an eye on the reorders because it's a factor of how fast those are selling from our customers' shelves. So the weather could still have a little bit of a lag effect there, so I wouldn't get too carried away extrapolating forward.

But the good news is from the HVAC standpoint is here, in Dallas at least, we are expecting over 100 degrees for the next week or so. And so as the summer heat sets in, those items are going to sell through at our distributor customers and we should see reorders be strong. But again, I would not necessarily extrapolate mild winter plus these really strong numbers in March into the numbers going forward on a linear basis.

Okay. And the incrementals there, the incremental margins were a little lighter than anticipated. They were the weakest, I guess, in at least seven or eight quarters. Anything product-mix-related there or material price increase maybe that is weighing on that? And just sort of what your thoughts are in terms of incrementals going forward?

Yes, this is Gregg, Joe. We did see some impact in our margins not being quite as strong on the incremental side. That is due to the legacy architecturally specified building products. They tend to be very profitable sales, and so their sales were down in the quarter, which is why it's so important looking forward that we talked about the backlog and that we are tracking that and it is ticking upwards.

But that definitely put a drag on the performance in the quarter of not having the incremental improvement that we've seen in the past. We continue to see overall operating margin fall through from an incremental standpoint in the low to mid 30%s in that business on a normal mix cycle. And we believe that there is still ample headroom as we increase volumes as we don't need to increase our footprint for those volumes.

Okay. And then I believe Greco had a big project announced last year. I want to say it was in Toronto, but somewhere in Canada, I think. What is the timing on that project and how significant is that going to be to the performance of the segment overall this coming this year?

Yes, so the project you are talking about is Eau Du Soleil. It is in Toronto. The total award was just under $6 million. That is shipping now. It should ship mostly through fiscal 2019.

It is a large project; it is one project in all of our architecturally specified building products. So I wouldn't necessarily look at that and say that's an uptick in our total sales there. It just helps us to solidify what we would expect in fiscal 2019 for our businesses.

Okay. And then I just had a couple questions on specialty chemicals. The margins have been quite weak recently. I'm just wondering how to think about margins for fiscal 2019.

Yes, so the margins were impacted in Q4 by the continued negative sales mix of energy-related products. And then as I mentioned on our prepared remarks, we did have some discrete costs in the fourth quarter that we didn't adjust out.

Those totaled around $700,000 and were related to some receivable write-offs as well as some employee benefit costs. We don't expect those to repeat, and so we still expect that business to improve.

We are working very hard on improving our margins, working on asset utilization, particularly on the small fill, which is the energy-related products, to improve those margins. And so I think we will see a benefit in our margins as we move forward.

And then lastly, I would say is, as Joe has mentioned previously and I think we have said on prior calls, the mining and international that we have been focusing on, that's more of our legacy mining products, which have higher margins, which is why we have been focusing there. It continues to help to offset the domestic decline.

Now, mining in total is not a big number, but it's clearly an area of focus for us. And the mining market -- addressable market that we serve internationally is a very large market, which is why we are focused there. And as we grow that, that will also further help our margins. But again, we are coming from a pretty small base. So it is going to take some time to benefit there.

Okay, and then last one for me. Just at specialty, ex-energy and mining chemicals, could you talk about how the rest of the business is doing and trending and how that's looking in fiscal 2019?

Yes, so that would basically be HVAC and plumbing. Those are going to trend and continue to trend just like the HVAC and plumbing within industrial products. The fact that those are effectively products and sales that would have been in the former S&A part of CS&A that has moved into specialty chemicals, so it will create some seasonality for us in fiscal 2019 that spec chem previously didn't have.

And so we will see, just like in industrial products, a weakness in our fiscal Q3. But in fiscal Q2 and -- fiscal Q1 and Q2, there will be a slight uptick. But they are going to trend pretty much just like the rest of HVAC and plumbing does for our businesses.

So I mean, I saw -- I thought energy is really doing well right now, just given rig count and production levels. And I would think that would be leading the segment. Is HVAC and plumbing below the sort of 5% revenue growth that we saw in the quarter?

Well, energy is leading the segment. I think when you look at it in total, as we saw in our fiscal Q3, the rig count has stabilized and so you don't see a ton of increase in energy. But energy is by far the largest piece of that segment. HVAC and plumbing is a much smaller piece, but it's still there.

And Joe, we also have some general industrial there that is going to be more like GDP growth. So you have got that weighing it down a little bit as well.

And rail is still down. Rail has continued to decline because the Class I railroads still are not putting the lubricants on like they used to.

Right. Okay. I understand. All right, thanks a lot. I appreciate it.

Thank you. Mr. Armes, there are no further questions at this time. I will turn the floor back to you for any final comments.

Great. Well, thank you once again for joining us bright and early this morning. Appreciate everyone's interest in CSW Industrials and look forward to speaking to you again next quarter. Thank you.

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