CSW Industrials, Inc. (CSW) Q1 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the CSW Industrials, Inc. First Quarter 2017 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Tom Cook with ICR. Thank you, Mr. Cook. You may begin.

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 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. 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 can 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 include an analysis of adjusted operating income, adjusted net income and adjusted earnings per share, which are non-GAAP financial measures of performance. These non-GAAP measures should be used as a supplement to and not as a substitute for operating income, net income and earnings per share computed in accordance with GAAP. For a more complete discussion of adjusted financial measures, see our earnings release. I will now turn the call over to our Chairman and Chief Executive Officer, Joe Armes.

Thank you, Tom. Good morning, everyone. Thank you for joining us on the call today. We experienced a challenging first quarter of fiscal 2017. Volumes and energy-related end markets remained at trough levels and our exposure to rail end market came under significant pressure, which our customers have largely attributed to indirect exposure to weaker commodity markets. During their recent earnings calls, our customers have announced reduction in new rail car production of approximately 50%, which had a direct correlation on our sales decline and products sold into the rail manufacturing markets. There's also been a drop off of almost 12% in carload traffic, which has negatively impacted sales of rail lubricants. With that being said, when assessing our first quarter results beyond the headline numbers, there were many positive and encouraging developments to highlight. First, after taking into account public company costs, which were not in the prior year financials because we were not a public company at that time and onetime items during the period, we were able to hold margins relatively stable compared to the prior year. This stemmed from the collective work of our management teams across our operating segments to reduce costs, combined with the strong performance in our non-energy-related end markets, namely in our Industrial Products segment. Second, we made progress toward diversifying our end market exposures in our coatings segment and we expect new customers to contribute revenue of about $6 million annually on a run rate basis as we ship products to these new customers throughout fiscal 2017. While this volume did not benefit the current quarter, we were very pleased to see this level of quoting and order activity and new applications for our products. Third, we are proud to announce that Strathmore was recently named the Coatings Supplier of the Year by Trinity Industries, an important customer to our coatings segment. This award highlights the quality of our specialty coatings products and strengthens our view that despite near-term cyclical challenges, coatings remain a compelling opportunity for long-term growth. And lastly, the R&D investments that we have made in our architecturally specified products division for large scale smoke curtains have resulted in new revenues exceeding our expectations. These innovative products can be found in marquee projects, including most recently, the San Francisco Museum of Modern Art as well as projects for Facebook and Netflix. While our Industrial Products segment has earned stellar reputation for successfully identifying and executing bolt-on acquisitions, we believe this recent success in smoke curtains is a testament to our ability to drive organic growth through our product development efforts and the enhancement of existing products. Taking a deeper look at the financial performance in the first quarter, we can summarize our results by 2 contrasting themes. First, demand for our products supporting HVAC and architecturally specified building products showed continued strength and delivered record setting volume in multiple categories. This tailwind was offset by lower volume in rail, energy and in general industrial end markets, which was predominantly driven by direct and indirect exposure to lower energy and other commodity prices. Together, this led to a 5.4% decline in consolidated revenue to $84.1 million. Covering these themes individually, strength in HVAC, plumbing and construction-related products drove almost a 9% revenue increase in our Industrial Products segment, while strong margin performance increased segment adjusted operating income by almost 11% to $10.8 million. Despite our new operating structure having limited operating history to highlight the magnitude of this performance, I will note that HVAC, plumbing, fire and smoke protection products, all achieved record sales level in the first fiscal quarter. In our Specialty Chemicals and Coatings, Sealants & Adhesives segment, depressed commodity prices accounted for top line weakness in both segments. As has been reported by several of our OEM customers, rail car production volume has declined approximately 50% compared to the prior year, which has led to a corresponding reduction in demand for our specialty coatings given our current exposure to these markets. This reduction in volume has been mostly attributed to a decrease in commodity markets and its impact to lower track cargo volume, which also affected demand for our specialty retail -- of our specialty rail lubricants. Primarily as a result of these dynamics, sales in our Coatings, Sealants & Adhesives and Specialty Chemicals segments were down 17.7% and 14.8%, respectively. Looking to the balance of the year, we do not expect meaningful improvement in these end markets, and have consequently commenced a program to further rationalize our footprint and reduce costs in our Coatings, Sealants & Adhesives segment. Chris will add some specifics in a moment, but we expect this initiative to provide an annualized savings of between $2.5 million and $3 million and to reach a full run rate by Q4 of this fiscal year. Turning to the profit in the quarter. As I noted, we were pleased with our ability to maintain segment-level profitability despite significant pressure in 2 of our 3 segments, which was evidenced by total segment adjusted operating income of $15.2 million or 18.1% of sales compared to $16.5 million or 18.6% of sales in the prior year period. At a consolidated corporate level, excluding onetime items, our adjusted operating income declined to $12.4 million compared to $16.5 million in the prior year as the comparable period did not include public company costs or the investments we have made into our corporate infrastructure. Looking forward to the balance of the year and our end markets, we expect the predominant themes of the first quarter to persist through fiscal 2017. We are optimistic that our Industrial Products segment will continue to drive performance, which is supported not only by a robust market but also by continued progress toward the integration of recent acquisitions and the continued success from new products that we have introduced or will be introducing soon. In our Specialty Chemicals segment, we believe volume in energy end markets is stabilizing but will remain at reduced levels, while a weaker overall commodity backdrop will indirectly pressure demand for our rail and industrial lubricants. In our Coatings, Sealants & Adhesives segment, lower OEM rail car production rates are expected to persist, but we do expect our revenue diversification efforts to moderate volume pressures as the year progresses and the plant facility consolidation that Chris will discuss in more detail later to significantly reduce our costs and improve profitability. It's a challenging environment, so we are focused on the factors that we can control and view our efforts to react quickly to changing market dynamics as a high priority and a core competency of our senior leadership team. We see a clear path ahead of us to manage through the difficult environment in energy and rail to fully capitalize the potential of our commercial and residential construction end markets. With that, I will turn the call over to Gregg for a closer look at the numbers.

Thanks, Joe, and good morning, everyone. Before digging into the numbers, I would like to provide an update on our financial initiatives to migrate from 6 individually managed private businesses to a single integrated operation with a centralized financial support system. These efforts are designed to streamline our reporting, provide real-time information, improve management tools to enhance analytics and enhance our reporting and transparency to the investors. Prior to my arrival last quarter, the team was in process of rolling out a new consolidation system, which enables centralized reporting on a shared system. I'm happy to report that as of the first quarter, we have completed Phase 1 of this integration and we were able to close the quarter on the new system. This is a significant first step as it included an integration effort at all of our operating locations. Phase 2, which is currently underway, includes the designing and implementation of a new set of analytical tools to improve our understanding and reaction time to market events and we expect to see the benefits of this with our second quarter close and further enhancements through the balance of the year. Since my arrival, I have completed site visits at nearly all of our operating locations and have collectively worked with financial leadership across the organization to identify relevant operating metrics, which we believe will prove valuable for internal and external analysis. In addition to the metrics, I'm working with our financial team and our external consultants to ensure we are Sarbanes-Oxley and COSA 2013 compliant by the end of the fiscal year. While we still have a lot of work ahead of us, we expect to provide progress updates throughout the year and roll out new analytical measures to help investors understand financial results at the completion of Phase 2. Now turning to our financial discussion of the first quarter, I would like to remind everyone that I will be referring to our adjusted results that exclude onetime items where noted. These adjustments primarily exclude restructuring charges, costs related to the CFO transition that took place during the quarter and other onetime items during the period. For a full reconciliation of GAAP to non-GAAP results, please refer to our earnings press release on our website. Consolidated fiscal quarter -- consolidated fiscal first quarter revenue decreased 5.4% to $84.1 million compared to the prior year period of $88.9 million. Lower sales in the quarter were primarily attributable to decreased volumes in our Coatings, Sealants & Adhesives and Specialty Chemicals business segments, specifically within the energy and rail end markets. This is partially offset by higher volumes in the HVAC and architecturally specified building product end markets and incremental revenue from acquisitions completed in the past 12 months. Now looking at our segment-level revenue and operating income. Revenue in our Industrial Products segment increased 8.8% to $43.5 million compared to $40 million in the prior period. The increase in revenue was the result of higher sales volumes and a favorable pricing -- and favorable pricing and mix. Our Industrial Products segment adjusted operating income increased 11.1% to $10.8 million over the prior year level of $9.7 million. Segment adjusted operating margin improved 50 basis points to 24.7% during the period. In our Coatings, Sealants & Adhesives segment, revenue decreased to $23.4 million compared to the prior year level of $28.4 million or a 17.6% decline. Lower sales were mainly attributable to decreased OEM rail car volume, partially offset by increased sales of fire stopping sealant products, improved pricing and net revenues attributable acquisitions. Segment adjusted operating income in the first quarter of 2017 decreased to $2.6 million compared to $4.1 million in the prior year, primarily as a result of lower sales volume and reflected the segment adjusted operating margin of 11.2%, marking a 320 basis point decrease compared to the prior year. In the Specialty Chemical segment, revenue decreased $17.2 million compared to the prior year level of $20.2 million or 14.9%. Lower sales were attributable to weakness in energy and rail end markets, partially offset by increased sales from acquisitions. Segment adjusted operating income in the first quarter of 2017 decreased to $1.8 million compared to the prior year level of $2.7 million and marked a 310 basis point reduction in segment adjusted operating margin to 10.4%. The lower segment profitability was the result of lower volume and an unfavorable product mix. Consolidated gross profit in the first quarter of fiscal 2017 was $38.2 million, a 5.5% decrease compared to the prior year level of $40.4 million. As a percentage of sales, gross margin was approximately flat at 45.4% compared to 45.5% in the prior year period. The unfavorable impact of decreased sales on our absorption and fixed manufacturing costs was mostly offset by changes in product mix and benefits from strategic initiatives to rationalize the company's global footprint and achieve cost savings through our procurement program. Consolidated operating expenses increased 17.7% to $30.8 million or 36.6% of sales compared to the prior year level of $26.2 million or 29.4% of sales. Increased operating expenses were attributable to our CFO transition and other severance costs, other personnel and public company costs as the prior year quarter did not have most of these public company costs and restructuring costs associated with the consolidation of facilities. This was partially offset by transaction costs in the prior year that were nonrecurring. Fiscal first quarter 2017 operating income was $7.4 million compared to the prior year period of $14.3 million. On an adjusted basis, operating income was $12.4 million compared to the prior year level of $16.5 million. Adjusted operating margin declined 390 basis points to 14.7% compared to the prior year period of 18.6%, which entirely reflected costs associated with being an independent public company and investments we have made in our corporate infrastructure as prior year results were on a pro forma basis prior to the spin-off from Capital Southwest. Consolidated net income for the first quarter was $4.1 million or $0.26 per diluted share compared with net income of $8.7 million in the prior year period. Net income included approximately a $600,000 gain in other income, which resulted from the sale of nonoperating assets and the favorable impact from foreign currency hedges. While we generally have minimal exposure to foreign currency, during the first quarter we identified a possible risk in our cash holdings and successfully protected around $6.5 million of pounds sterling and avoided a $1 million transaction -- translation loss ahead of the British Exit from the European Union through a forward hedge and converting some of our pound sterling to U.S. dollars. Adjusted for onetime items in a normalized tax rate, net income was $8 million or $0.51 per diluted share compared to net income of $10.1 million or $0.65 per diluted share in the prior year. Our net debt at quarter end was $49.6 million and we closed the quarter with $34.9 million of cash on our balance sheet and had $178.5 million of borrowing capacity on a revolving credit facility providing plenty of 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 providing an update on our corporate-wide integration initiatives, followed by some additional details of the restructuring plan we are initiating in our Coatings, Sealants & Adhesives segment. As we've communicated previously, since the commencement of the spin-off transaction, we've identified $7.5 million in annual savings, primarily through facility consolidations and our global procurement initiative. I'm pleased to report that we have made significant progress towards these programs. As of the end of the first quarter, we have ceased virtually all production in our Jet-Lube Houston facility and have completed the closure of Jet-Lube Canada. While it will take some time to fully realize the $5.5 million in savings under this initiative, we did realize some modest benefit in the first quarter, and will be in a position to realize the full run rate by April 1, 2017. Regarding our company-wide procurement program, we have put in place new purchasing agreements that will yield more than $2 million in annual savings we've previously communicated and we continue to identify additional opportunities beyond our original commitments. As a result of the additional opportunities, we now anticipate saving approximately $2.5 million in fiscal 2017. The benefits of this program resulted in savings of $600,000 in the first quarter. As you may recall, last quarter we detailed a path to improve profitability in our coatings business, and we have reached several milestones. First, of the $2 million in procurement savings company-wide, $1 million of that savings was expected in the Coatings, Sealants & Adhesives segment. I'm happy to report that as of quarter end, we've already achieved a run rate of around $750,000 annually. Second, we continue to make progress towards the exit from our expensive toll manufacturing arrangement in Houston and this should be complete by the end of October of this year. Third, we closed one of the manufacturing facilities in Syracuse, New York, as planned last year. And fourth, we have launched a sales diversification program in an effort to reduce cyclical exposure to the OEM rail market. As Joe mentioned, we had some considerable success in this area and were selected by multiple new customers and end markets, which include coatings for industrial racks, propane storage tanks, aboveground storage tanks and automotive filter applications. In total, we expect sales to these new customers to amount to around $6 million per year going forward. In addition to these previously disclosed initiatives, we announced in our earnings release today additional programs to further restructure the business, given the recent volume declines and current market conditions. These incremental actions further optimize our manufacturing footprint by reducing our manufacturing locations and relocating certain manufacturing to maximize efficiency. In total, we estimate this restructuring will produce between $2.5 million to $3 million in annual additional savings. We expect to complete these additional programs by the end of the calendar year, which will include some onetime restructuring costs, which we estimate to be in the range of $2.5 million to $3 million and capital investment of between $1 million to $1.25 million. Before turning the call over for your questions, I wanted to close by providing an update more broadly on progress that we have made to deepen our team and drive excellence across the business. As you know, we restructured our leadership team and appointed segment leads several months ago. And in the first quarter, we continue to build out and upgrade our staff at the next level down. This includes a new VP of Sales in our Industrial Products segment and on our coatings business, which now includes several new team leads in the areas of sales, business development and quality assurance. So with that, I will turn it over to Joe for closing remarks.

Thank you, Chris. In closing, although we acknowledge a challenging quarter, we would also note that our broadly diversified portfolio of products and the diversity of our end market exposures provided stability under stressed market conditions. Our balance sheet remains strong and we're building a team able to execute on our long-term strategic priorities under any market conditions. We believe we are taking the steps necessary to manage through the current cycle and to position the company to deliver long-term, sustainable value for our shareholders. Let me take this opportunity to thank all of my colleagues at CSW Industrials as we continue to serve our customers and to steward well the capital entrusted to us by you, our shareholders. Thank you for your interest in CSW Industrials. And now operator, we're ready to take questions.

[Operator Instructions] Our first question comes from the line of Jon Tanwanteng from CJS Securities.

Can you talk about the timing and the margin profile of the new businesses you're seeing in coatings? How do you expect that to ramp?

It's going to ramp -- this is Chris. It's going to ramp through the year. This is business that is additional incremental business in new markets. The question was more on the timing or the...

The timing and the margins as well.

Margins are going to be in line with typical coatings margins and the timing will be phased in over the course of the year. It's not always 100% in our control but we certainly expect to see this additional incremental sales revenue as we roll out through the rest of this fiscal year.

Okay, great. And just to clarify the $2.5 million to $3 million in run rate savings you're expecting, is that in addition to the previous synergies and savings you discussed of $7.5 million?

Yes, it is. This is in addition, and this is really in the Coatings, Sealants & Adhesives segment.

Okay, got it. So over the year or by the end of the fiscal year, about $10.5 million, is what you're talking about.

This is Gregg, Jon. Yes, it would be between $10 million and $10.5 million on a run rate basis as we exit this fiscal year.

Okay. And just a quick question on the corporate expenses, ex-items, you did $2.8 million in the quarter. Is that the run rate we should expect going forward, and should we continue to expect additional onetime expenses like the Sarbox consulting fees?

The Sarbox and consulting fees, primarily the Sarbox, I think we'll see some additional consulting as we continue to roll that out and become compliant this year. That the onetimes on that are probably more heavily weighted to the first quarter as we are in the process -- as we were in the process of designing the controls and putting systems in place, but we'll see a little bit more of it throughout the rest of the year. As to the run rate of the corporate expenses, I would say that those are higher than what we would expect, both with and without the onetimes, as we saw some timing of costs relative to some financial and professional fees relative to the audit taxes, things of that nature, that tend to be more heavily weighted in the first quarter.

Okay, great. That's helpful. And finally, can you just update us on the M&A environment, maybe what you're doing from a due diligence standpoint of what things like Strathmore, and how active are you in general?

Yes, this is Joe. We're very active in looking for acquisition opportunities. Similar to our statement on last quarter's call, the market continues to be a tough environment to find value. Valuations have been stretched and we're committed to a very disciplined approach. And so at this point, we have not identified -- we haven't closed any acquisitions because of valuations in large part but we're very actively looking. Primarily what we're looking for are strategic add-on acquisitions, acquisitions that allow us to leverage our distribution channels, acquisitions that would be oftentimes described as product line extensions. And so those are the type of acquisitions that we're looking for. And if we can find those at a reasonable value, then we would be very interested in that. However, at this point, valuations seem pretty high to us.

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

Joe, on the fall-off in the rail business, obviously, the traffic volumes are what they are as well as the car load production. But is this just a volume decline, are you seeing any pricing pressure in either of those areas, either in the coatings or the friction management side?

Fortunately, we have not. We've really seen really decline in the orders from customers and their decline in their business. We have not seen price decline and we have not -- pricing pressure, and we have not lost share, to our knowledge. I mean, it appears to us that we are down in lockstep with the industry.

Great. And when I'm looking at the broader industrial markets, you highlighted weakness in your prepared comments. Are there any pockets of strength under that? It's pretty obviously broad category but do you see any strength in that industrial category that you laid out?

This is Chris, Liam. It's tough to say specifically. The industrial segment is a very broad brush that we use to describe everything that's not one of the other end use markets. So I can't really pinpoint one specific that would be an island of strength in the industrial end market.

In that area, do you see any continued momentum in new product introductions in that space?

Well, obviously, we highlighted in the Industrial Products area, in the Industrial Products segment, we talked about our new large screen curtains, which has been a nice success story and something that we just introduced, really, last fiscal year, and we're starting to see a nice uptick in that business. And so I guess, the other -- just to kind of touch upon themes we've hit in previous quarters, Liam, we continue to introduce some of our new products like the Deacon Sealants into a broad range of industrial end markets. And we're starting to see some uptick there through our distribution channels, so we're excited about that. And we believe that is going to be an area of strength going forward, is to be able to get those products into the hands of a broad range of industrial customers.

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

Great. Thank you again for joining us. We appreciate your interest and look forward to speaking to you again next quarter. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.