Greetings, and welcome to CSW Industrials Second Quarter 2017 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Tom Cook. Thank you. Please go ahead

Thank you, operator. 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 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'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 between the 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 and adjusted operating margin, 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, operating margins or net income computed in accordance with GAAP. For a more complete discussion of adjusted operating income, operating margin, net income and earnings per share, see our earnings release. And with that, I'd like to 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. Our performance in the fiscal second quarter reflected 3 dominant trends affecting our business. First, strong organic sales exhibiting above market growth for products serving the HVAC, plumbing and architecturally specified building products end market. Second, the continuation of weak demand for products serving commodity and rail end markets. And third, a reduction in operating costs from our restructuring and integration efforts as we work to position our company for long-term growth and profitability. Putting this all together, before taking into account higher independent public company costs, which were not included in our prior year comparable, our segment-level adjusted operating income was relatively flat with the prior year despite lower sales. Including independent public company costs, our adjusted operating income was $11.5 million compared with $14.1 million in 2016. In our Industrial Products segment, sales were up 15.7% compared to the prior year, driven by strong demand for our HVAC, plumbing and architecturally specified building products. HVAC end market sales continue to exhibit strong growth year-over-year as we remain focused on innovative, high-demand products such as ductless mini-split accessories, refrigerant locking caps and condensate cut-off switches. As a point of reference, our net sales of HVAC products through the first half of fiscal 2017 have already surpassed our total net sales of HVAC products in fiscal 2014. HVAC continues to be our largest and fastest-growing end market. Industrial Products segment growth has also been bolstered by the success for our large smoke-containment curtains as we are seeing the benefits of the R&D investment we made in the past 3 years. And Chris will discuss this in more detail later during our call. Turning to our Coatings, Sealants & Adhesives segment, similar to last quarter, declines…

Thank you, Joe, and good morning, everyone. As Joe mentioned, our consolidated revenue was impacted by 2 discrete trends, including above-market demand for our construction-related products, which was more than offset by a reduction in demand for our products serving commodity-related activity. Consequently, our consolidated fiscal second quarter revenue decreased 4.3% to $80.1 million compared to the prior year of $83.7 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 was partially offset by higher volumes in HVAC and architecturally specified building product end markets and incremental revenue from acquisitions completed in the past 12 months. Looking at our segment-level revenue and operating income. Industrial Products segment revenue increased 15.7% during the quarter to $41.9 million compared to the prior year of $36.2 million. The increase in revenue was the result of higher sales volumes and favorable pricing trends. Industrial Products segment operating income was $9.9 million compared to the prior year of $11.7 million as the prior year included a onetime pension curtailment gain of $3.2 million that did not recur in the current period. Industrial Products segment adjusted operating income was $9.9 million compared to the prior year of $8.5 million. Segment adjusted operating margin improved 20 basis points to 23.7% during the period. In our Coatings, Sealants & Adhesives segment, the revenue decreased to $23.0 million compared to the prior year of $28 million. Lower sales were mainly attributable to decreased sales volumes in the rail markets, partially offset by increased net revenues attributable to acquisitions. The segment operating loss in the second quarter of 2017 was $1.6 million compared to operating income in the prior year of $4.9 million. The lower operating income…

Thanks, Gregg. I'd like to begin today by providing an update on our corporate-wide integration initiatives, followed by a report on the progress of our restructuring plan we have initiated in our Coatings, Sealants & Adhesives segment. As we communicated previously, since the spin-off transaction, we have identified approximately $10 million to $11 million in annual savings, primarily through facility consolidations and our global procurement initiative, and we continue to make progress on these programs in our second quarter. This was the first quarter that we produced all Jet-Lube Houston volume in our Rockwall facility. This came with some operational challenges as our teams ramp up to full speed and resulted in the $1.5 million increase in backlog that we planned to ship in the second half of our fiscal year. We did, however, see some of the cost savings associated with this initiative, as Joe mentioned, and as indicated by the higher adjusted margin rates reported on our Specialty Chemicals segment despite this revenue headwind. We continue to expect to achieve a $5.5 million savings run rate by April 1, 2017, inclusive of the consolidation of Jet-Lube Canada. In addition, we will be ceasing manufacturing of lubes and greases at our Jet-Lube U.K. operations, instead using the U.K. facility to package and ship products. We expect this action to provide incremental benefits to our cost-savings program, and we will communicate expected cost savings as we get closer to completion. Regarding our procurement programs. We remain confident in our ability to yield more than $2.5 million in annual savings, as previously communicated. Turning to our path to improve profitability in our Coatings business, we reached several additional milestones in the quarter. First, on our last call, we confirmed the closure of 1 of the 2 manufacturing facilities in Syracuse, New…

Thank you, Chris. In closing, we are focused on driving above-market organic growth in our construction-related end markets and navigating appropriately through challenged commodity-related end markets, reducing costs and controlling what is -- within our ability to control. Our broadly diversified portfolio and end-market exposure provide stability under stressed market conditions as demonstrated in the second quarter. Our balance sheet remains strong, and we are building a team to aggressively pursue our long-term strategic priorities. Through these actions, we believe we're taking the right steps to manage through the current cycle and position the company to deliver long-term, sustainable value for our shareholders. Thank you for your interest in CSW Industrials. Operator, we're now ready to take questions.

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

Can you start with a little bit more detail on the timing and absolute dollars amounts of the cost reductions you expect over the rest of the year? And maybe just to clarify, I heard you expect Jet-Lube and Whitmore to be completed in fiscal '18, and I think I heard Chris saying April 1, 2017. I know April 1 is fiscal '18, but I just want to make sure what I heard.

Jon, this is Gregg. Yes, the savings that we expect for the balance of this year are the -- are what we had talked about of roughly $1.5 million to $2 million, and that's primarily related to the Jet-Lube integration. So the total for the year in addition to the $1.4 million we've already captured in the first half of the year should put us somewhere around $2.9 million to $3.5 million of savings for that integration. With respect to the procurement savings, as we talked before, that will roll into inventory before we will see it really hit our P&L. And so a lot of that is highly dependent on the turns at the given locations. So I think the safest thing right now is just to assume, that $2.5 million, we'll truly see all of it next year, next fiscal year with some limited savings here in the back half. Because it rolls through inventory, it gets much harder trying to actually quantify the exact amount of savings that you get at any point in time. But we clearly will see a small amount of that this year. And then finally, with respect to the restructuring in our CS&A segment, that we expect to have completed by the end of this fiscal year for the full savings next year. And so again, we would expect the full savings of all 3 initiatives to be roughly the $10 million to $11 million.

Right. So that run rate will be entering fiscal '18?

That's correct. We should see the entire amount in fiscal '18. Obviously, with a piece of that amount already having been captured in fiscal '17 to where the incremental amount in fiscal '18 will be less than the $10 million to $11 million, but the full $10 million to $11 million will be there in fiscal '18 on a run rate.

Got it, that's helpful. And just on the Specialty Chemicals segment, can you give me some more color on the demand there? I get you did push out some volume from the transition. But even if you add that back, there was a sequential decline. Should we assume that, that is the trough quarter for revenue and margins there? Or are there more headwinds from energy and rail incoming?

Again, this is Gregg. I think that we do, at this point, believe that that's a trough quarter. If you look at our revenue in the quarter, it was $15.2 million. If we did had not had the production issues that caused our backlog to grow $1.5 million, that would have put us at $16.8 million compared to the prior year of $19.8 million. If you then roll into Q3 of last year, we were at $18.1 million of total sales, and we believe that we have hit that trough. But a lot of that also is dependent on what future market conditions come out of there.

Gregg, can you talk about the impairment a bit? I assume that's from the closing of the facilities from Strathmore. Just a bit more detail on that, number one. And number two, Joe or Chris, maybe talk about the overall growth expectations for the coatings business given the continued pressure in rail or maybe discuss a balance between the railcar business and the growth of all these new end markets you're after.

Sure, this is Gregg again. On the impairment, so that was an impairment of our Strathmore trademark. It was driven as a result of the closure of the Syracuse facility. The accounting for asset impairments is extremely prescriptive, and the result of the restructuring is what triggered us to have to look at that, at whether or not we had any impairments. Typically, our measurement period on viewing impairments would be the fourth quarter of every fiscal year unless there is an event that causes you to look -- to need to look sooner, which obviously the restructuring did cause us to look at that. The trademark impairment is based on future revenues, and under U.S. GAAP, assigns a royalty rate that has to be consistent with how we -- how it was originally set by the valuation firm. And so with the lower overall market demand that's out there and the fact that we are closing that facility, it caused us to take a $2.8 million impairment that was obviously noncash. Assuming market conditions remain stable and the future of what we expect, we would not anticipate any further impairment for any of our intangibles.

And Joe, this Chris. Regarding the coatings growth initiatives, as you know, historically, our coatings business, the largest end market was new railcars, new tank cars. And so we have put a tremendous effort into diversifying our end markets. And as I mentioned, we've had some success. And this year, we will actually generate $6.5 million of sales in new applications. In addition to that, we structured our sales force to make sure that we had the right team on the field that was going to get us into some new end markets that we believe will be excellent -- provide excellent demand for our existing products. And so it's really a 2-pronged approach to grow our coatings revenue. And as I mentioned, these efforts have increased our sales funnel, our pipeline of new sales opportunities by approximately 40%. So we're very excited about our sales growth initiatives in the coatings segment.

Okay, got. And then just finally on the industrial side, should we expect the same kind of growth going forward on a sequential basis given you're entering a seasonally weaker quarter in terms of HVAC sales?

Yes, I just want to be real crisp -- this is Gregg, I want to be crisp on that. We would expect continued year-over-year growth like we saw -- like we've seen, thus far, this year. But again, Q3 sequentially is our lowest quarter. So it will definitely be down versus our Q2 fiscal 2017. But if you look at Q3 fiscal '17 versus Q3 fiscal '16, we would fully expect those end markets and our sales in that -- in those end markets to see the same amount -- same type of growth that we saw in Q2 over the prior year.

Okay, got it. And then just one final question for Gregg. What went into that other income amount? Is that -- any recurring at all or any more detail on that?

Yes, so the other income is primarily FX gains. You will likely recall, last quarter we spoke about how we protected some cash that was sitting over in the U.K. And prior to Brexit, we moved that cash from pound sterling to U.S. dollars. And as the pound sterling has continued to depreciate to the dollar, that triggered some of the gain there. That's the bulk of the gain. It's FX related.

And given currency moves since then, I could assume there'd probably be a little bit more in Q3?

Likely, yes. I mean, that's something that the way that the U.S. GAAP works is you're not allowed to treat that under normal accounting, so it gets marked-to-market every quarter.

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

Joe, you've had a lot of success or early success diversifying your product base either with new products on the R&D side, as you mentioned, in industrials. And looking at adjacent market or new uses for existing products. How is the margin profile of these in either adjacent markets or new applications?

They're actually very strong. We're looking -- always looking at opportunities to actually improve our margins. And so one of the kind of metrics that we look at, whether it be acquisition or new products, is can we grow our margins. And so, so far, that has been the case. Now that is also limited. Our ability to do acquisitions and our discipline there has been seen the last few quarters, where we haven't announced an add-on acquisition, and part of that is because we do not want to diminish our margin profile. We feel like that sets us apart from other comps in the market, and that's something we're pretty jealous about.

And just touching on acquisitions then, understanding that you've got limited resources either on the new product introductions or acquisitions, how is the pricing or competitive environment? And how does that affect your pipeline, if the right one came along or if the right type of business can -- presented itself?

Right. Well, we certainly have the financial flexibility to do bolt-on acquisitions. We have the bandwidth from a management standpoint. We would love to do a couple of add-on acquisitions here in the back half. Having said that, the marketplace is still pretty frothy, a lot of capital available. We have been outbid on several opportunities that we thought were very attractive, but our return hurdles remain the same. And so the pipeline is good. The opportunity set in front of us is pretty robust, there -- but we narrow that field by having kind of margin profile that we require, growth profile, all the metrics that we require and then, of course, a pretty high hurdle rate on returns. And so opportunities are out there. But as we sit here today, we don't have anything to report because valuations have just not been to our liking.

We've reached the end of our question-and-answer session. I would like to turn the floor back over to management for any closing comments.

Great. Again, thank you, everyone, for joining us. We really appreciate your interest in CSW Industrials. And I also want to take this opportunity to thank all my colleagues at CSW Industrials as we continue to serve our customers and to steward well the capital entrusted to us by our shareholders. Thank you, everyone.

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