CSW Industrials, Inc. (NASDAQ:CSWI) Q3 2023 Earnings Call Transcript

CSW Industrials, Inc. (NASDAQ:CSWI) Q3 2023 Earnings Call Transcript February 2, 2023

Operator: Greetings, and welcome to CSW Industrials, Inc. Fiscal Third Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. . Please note this conference is being recorded. I would now turn the conference over to your host, James Perry, CSWI’s Executive Vice President and Chief Financial Officer. Thank you. Mr. Perry, you may begin.

James Perry: Thank you, Sheri. Good morning, everyone, and welcome to the CSW Industrials fiscal 2023 third quarter earnings call. Joining me today is Joseph Armes, Chairman, Chief Executive Officer and President of CSW Industrials. We issued our earnings release, presentation and Form 10-Q prior to the market’s opening today, which are available on the Investor portion of our Web site at www.cswindustrials.com. This call is being webcast and information on accessing the replay is included in the earnings release. During this call, we will make 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 today in our earnings release and the comments made during this call as well as the risk factors identified in 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. I will now turn the call over to Joe Armes.

Joseph Armes: Thank you, James. Good morning and thank you for joining our fiscal third quarter conference call. Once again, our team executed well in the face of economic headwinds. Our record third quarter results reflect the diligence and professionalism of our team members around the globe. Demand for our high value products remains strong. We are highly focused on managing our costs while pursuing market share growth. We have continued to deploy capital opportunistically while strengthening our balance sheet and liquidity through reducing our leverage ratio and proactively increasing our revolver capacity, thereby maximizing our ability to pursue future opportunities as they arise. We delivered impressive operating leverage, as EBITDA grew by 47% on 26% growth in revenue, while also generating $33 million in free cash flow equal to 19% of revenue.

In the current quarter, all three segments contributed to organic revenue growth of $23 million, driven primarily by the numerous price actions we have taken over the last two years. While we are still experiencing inflationary cost pressure, we have been able to partially offset these with productivity gains. We have seen reduction in the cost of shipping containers from Asia, as well as lower costs for certain raw materials, but still face higher costs for certain line items such as domestic freight. We have successfully maintained our pricing, thereby expanding our margins. However, the net result of these variables is that we have not yet returned to our historical pre-pandemic margins, which remains a goal for all of us here at CSWI. During the fiscal third quarter, we consummated the previously announced acquisition of Falcon Stainless.

This product line expands our offerings sold into our profitable HVAC/R and plumbing end markets. As a reminder, in our third fiscal quarter of last year, we closed the Shoemaker acquisition, which expanded our GRD offerings sold into the HVAC/R end market. During the fiscal third quarter, the Shoemaker, Cover Guard, AC Guard and Falcon acquisitions collectively contributed $12 million in revenue, all of which was reported in our Contractor Solutions segment. These acquisitions reflect the accretive nature of our capital allocation strategy and our focus on complementary product categories, and our existing end markets served. In the first nine months of fiscal year 2023, we deployed $105 million of capital via acquisitions, opportunistic share purchases, dividends and capital expenditures.

We continue to pursue both internal and external opportunities for growth, consistent with our disciplined risk-adjusted returns methodology and to maintain a pipeline of acquisition opportunities. In prior quarters, we have discussed strategic investments we made in working capital in an effort to mitigate shipping delays and other uncertainties with the global supply chain. I am pleased to report that these delays have eased, and our business leaders have shifted focus to reducing inventory and accounts receivable as prudent. This focus is intended to free up cash and reduce the accompanying interest expense. And I’m encouraged by the progress in recent months and optimistic about our ability to see continuous improvement in this area. I want to touch briefly on our segments, then James will provide the details on our performance.

Overall, I remain pleased with the performance of all three segments, and in particular with the leadership team’s response to changes in their markets. We are entering the busy season for our Contractor Solutions segment, and our team is gearing up for another year of growth that exceeds the industry average. The strength of this segment lies in leveraging our distribution network, optimizing acquisition integration and bringing high value products to our customers. Our recent acquisitions have been well integrated and the focus as always remains on serving our customers well, as we add new products to our portfolio of offerings. Our Specialized Reliability Solutions segment continues to exceed expectations. The capacity utilization in our main facility continues to increase, and our team there remains focused on top line and bottom line growth by driving operational efficiencies and offering the optimal mix of products.

Energy markets remain strong. And industrial end markets are stable. Our distributors remain cautious about their inventory levels, so we stay in close communication with them relative to demand. Our joint venture with Shell continues to gain momentum. And we expect to complete the previously announced capacity expansion project of our existing facility later this calendar year, which will allow for increased revenue and profitability. Our Engineered Building Solutions segment continued to grow with an increase of revenues of 7.6% year-to-date. And for a fourth consecutive quarter, this segment’s backlog reached an all-time high. We are seeing a slowdown in biddings for new projects, in line with recent AIA data that are highly focused on pursuing those projects undertaken by the highest quality developers with the highest likelihood of completion.

And our team is performing well in delivering on the current projects, albeit at a lower margin due to when those projects begin. Before I turn the call over to James, I would like to remind everyone of the demonstrated resiliency of our business model. Despite the expectation of many in the financial community of a recession this year, we remain well positioned. Strength of our business model include the diversification of our product portfolio and of the end markets we serve, as well as the consumable nature of many of our products that are used either in maintenance, repair and replacement applications or to extend the reliability, performance and lifespan of mission critical assets. Specific to our largest end markets, HVAC/R and plumbing, the products we sell and the value we provide are often non-discretionary, fundamental necessities for homeowners and businesses.

We have maintained a strong balance sheet that allows us to withstand market headwinds with ample liquidity that affords us the ability to pursue growth opportunities across our portfolio of businesses. At this time, I’ll turn the call over to James for a closer look at our results. And then I will conclude the prepared remarks with our strategic outlook.

James Perry: Thank you, Joe, and good morning, everyone. Our consolidated revenue during fiscal third quarter of 2023 was $171 million, a 26% increase as compared to the prior year period, driven by pricing actions and contributions from acquisitions. Consolidated gross profit in the fiscal third quarter was $66 million, representing 28% growth, with the incremental profit resulting primarily from revenue growth. Gross profit margin improved slightly to 38.5% compared to 37.7% in the prior year period, as strong revenue growth in the higher margin Contractor Solutions segment due in part to our recent acquisitions outpaced revenue growth in our other segments. Consolidated EBITDA increased by $31 million, or 47% as compared to the prior year period.

Consolidated EBITDA margin improved 18% as compared to 16% in the prior year quarter, driven by revenue growth, which outpaced incremental expenses. Reported net income attributable to CSWI in the fiscal third quarter was $16 million, or $1.01 per diluted share, compared to $9 million, or $0.59 in the prior year period. The current quarter includes $1.5 million, or $0.10 per share of tax benefit related to the release of an uncertain tax position reserve upon the closure of certain Vietnam tax audits. Our Contractor Solutions segment with $112 million of revenue accounted for 65% of our consolidated revenue and delivered 29 million or 36% total growth as compared to the prior year quarter. This was comprised of organic revenue growth of $17 million and inorganic growth of $12 million from the Shoemaker, Cover Guard, AC Guard and Falcon acquisitions.

Note that growth attributable to Shoemaker becomes organic growth starting with the current fiscal fourth quarter. Organic growth in the segment resulted from the cumulative benefit of pricing initiatives, partially offset by a slight decrease in unit volume as compared to last year. The strong revenue growth as compared to the prior year period was driven by the HVAC/R and architecturally specified building products end markets. Segment EBITDA was $28 million, or 25% of revenue, compared to $17 million, or 21% of revenue in the prior year period, as our margins continue to recover from the inflationary environment. We have started to recover a margin point as we’ve been able to maintain our pricing as certain costs in this segment have declined.

Of note, however, outside of the decline in ocean freight rates, many of our input costs remain high. So we are managing our overall cost structure carefully. Our Specialized Reliability Solutions segment achieved another impressive quarter of organic revenue growth of $5 million, or 16%, due to the continued benefits from pricing initiatives, strong end market demand, including energy and general industrial, and improvements in our operations and execution. Segment EBITDA and EBITDA margin were $5 million and 14%, respectively, in the fiscal 2023 third quarter compared to $5 million and 15% in the prior year period. Of note, we incurred $0.5 million one-time charge in the quarter for the termination of a small Canadian pension plan in this segment.

This is reflected in our EBITDA results. As Joe mentioned, with the ongoing addition of equipment in our Rockwall, Texas facility to support growth of the Shell & Whitmore joint venture, we are in a position to post a compelling exit rate as we progress through the fourth quarter and into our next fiscal year. Our Engineer Building Solutions segment revenue grew to $25 million, a 3% increase compared to $24 million in the prior year period. Bidding and booking trends remain strong. In fact, our year-to-date bookings and backlog increased by approximately 38% and 47%, respectively, as compared to the prior year period. As of the end of the fiscal third quarter, our book to bill ratio for the trailing eight quarters was almost 1.2 to 1. As Joe mentioned in his opening remarks, we ended December with the fourth consecutive quarter of record backlog in this segment.

Transitioning to the strength of our balance sheet and cash flow, we ended our fiscal 2023 third quarter with $15 million of cash and reported cash flow from operations of $84 million in the first three quarters of our fiscal year compared to $69 million in the prior year-to-date period. Of the $84 million of operating cash flow in the current fiscal year-to-date, $37 million was generated in the fiscal third quarter as compared to an aggregate of $47 million in the fiscal first half. While the working capital levels will vary from quarter-to-quarter due to seasonality and other factors, we have made progress in reducing the levels of safety inventory that we have strategically held in recent quarters due to the uncertainties in the global supply chain.

We have been and will continue to be committed to having the products our customers need. As supply chain constrains have eased, we have a laser-like focus on our working capital metrics at the business level and are committed to continuous improvement to free up balance sheet capacity and reduce our interest expense. As demonstrated by our cash flow this year, I am pleased with our progress and look forward to further refinement as we close out fiscal 2023 and enter fiscal 2024. Our free cash flow defined as cash flow from operations minus capital expenditures was $33 million in the fiscal third quarter as compared to $23.3 million in the same period a year ago. That resulted in free cash flow per share of $2.13 in the fiscal third quarter as compared to $1.47 in the same period a year ago.

Through the first nine months of the fiscal year, our free cash flow was $75.8 million or $4.87 per share as compared to $61.1 million or $3.86 per share in the same period a year ago. The impressive level of free cash flow drives our risk-adjusted returns capital allocation strategy which in turn enhances shareholder value. An important component when assessing our generation of cash flow as compared to a few years ago is the non-cash amortization of intangible assets that arise from multiple acquisitions in the last few years. That amortization figure alone is $16.4 million or $1.06 per share in the first nine months of this fiscal year as compared to $5.4 million or $0.36 per share in the nine months immediately preceding the acquisition of TRUaire in December of 2020.

During the fiscal third quarter, we were pleased to announce the expansion of our revolving credit facility capacity by $100 million through an exercise of the accordion feature. Of important note, this increase was effective with no change in terms or pricing despite an increasingly challenging credit market that many companies face. This additional capacity gives us increased flexibility to pursue investment opportunities without having to access the capital markets in the current uncertain environment. We are appreciative of the strong support shown by our bank group, a testament to our recent success and future opportunities for profitable growth. We ended the fiscal third quarter with $267 million outstanding on the now $500 million revolver, a $7 million increase compared to the prior fiscal quarter end.

As a reminder, during the fiscal third quarter, we invested $34.6 million of cash with the acquisition of Falcon. Our bank covering leverage ratio as of the current quarter end was approximately 1.5x, an improvement from 1.6x as of the preceding quarter end due to our strong EBITDA growth. As part of our broad capital allocation strategy, we remain committed to opportunistic share repurchases guided by our intrinsic value model. During the fiscal 2023 year, we have repurchased 336,347 shares for an aggregate purchase price of $35.7 million under our prior $100 million share repurchase authorization. In December, we announced that our Board of Directors had approved a new $100 million authorization that is available through the end of calendar 2024.

Our effective tax rate for the fiscal third quarter was 14.7% on a GAAP basis, due to the previously mentioned 850 basis point benefit we received when the tax audits for several years were closed in Vietnam and we were able to release the reserve on our balance sheet. We expect a 23% to 24% tax rate for the full fiscal 2023 year. As we look to close out fiscal 2023, we anticipate strong revenue growth across all three segments and at the consolidated level for the full year, which, when coupled with meaningful operating leverage, will result in strong year-over-year EBITDA and EPS growth as well as cash flow generation. We expect to benefit from continued stability in our raw material and freight costs. With that, I’ll now turn the call back to Joe for closing remarks.

Joseph Armes: Thank you, James. During the fiscal year-to-date period, we delivered record revenue of $562 million representing growth of 24%. Operating leverage on this growth drove 30% growth in EBITDA and 39% growth in adjusted EPS. In light of the strength of our fiscal year-to-date results, we expect year-over-year revenue growth of approximately 20% with an EBITDA margin of over 22% for the full year. These full year expectations imply fourth quarter revenue growth of approximately 9% as compared to the same period last year, with an EBITDA margin of approximately 23% in the fourth quarter. We are currently working through our budget process for our fiscal 2024, which begins on April 1. While there are headwinds in certain end markets, we expect to deliver consolidated revenue and earnings growth for CSWI.

We are focused on efficiency gains and cost reductions, but we plan to accomplish these objectives without involuntary reductions in our level of employment. We are committed to providing our customers with the high quality products and service that they expect from CSWI, and we will rely on the dedication of our team members to accomplish that goal. We are expanding margins and driving cash flow conversion. We are confident in our near-term and long-term opportunities with disciplined capital allocation, which is enabled by the strength of our balance sheet. We remain committed to enhancing sustainable growth and shareholder value, even in the face of economic uncertainty. By doing this in the past, we have consistently delivered outstanding financial results and we will utilize that same approach for the remainder of 2023 and beyond.

I’m pleased to share that for the third year in a row, Cigna has selected CSWI as a recipient of their gold level healthy workplace designation for demonstrating a strong commitment to improving the health and well being of our employees through our workplace wellness program. This reinforces our distinctive employee-centric culture and affirms our intention to be an employer of choice. My colleagues here at CSWI hear me say this often. At CSWI, we must and we will succeed. There’s no other option. But here at CSWI, how we succeed matters. Achieving these outstanding year-to-date results demonstrates our commitment to be good stewards of your capital and to our goal of driving long-term shareholder value. As always, I want to close by thanking all of my colleagues here at CSWI who collectively own approximately 5% of CSWI through our employee stock ownership plan, as well as all of our shareholders for their continued interest in, and support of our company.

With that, operator, we’re now ready to take questions.

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Q&A Session

Operator: Thank you. . Our first question is from Jon Tanwanteng with CJS Securities. Please proceed.

Jon Tanwanteng: Hi. Good morning. Thank you for taking my questions and congrats on the nice results. My first question is, I was wondering if you could talk about how much change you’ve seen or discussed or experienced just in terms of your overall macro expectations and visibility over the last two or three months? It seems we’ve got a bit by pretty much negative macro sentiments earlier in Q4, and things started to improve since then. Has that translated to any changes in your internal forecasts or discussions with customers as you go forward and heading into fiscal ’24? Just help us think about your visibility in today’s environment.

Joseph Armes: Yes, John, as you know, visibility is tough these days. And so our goal is be prepared for whatever eventuality. We think the strong balance sheet, the diversification of our business, the strength of our brands and the low cost, high value kind of products that we provide to our customers are going to be popular and profitable and great products to offer and a great business model, regardless of the economic backdrop. March is a really important month for us, late February, March for the pre-sale season in the HVAC business. And so we’ve got our eyes focused on that. But we’ll know more then. At this point, we don’t have any indications of any major changes in our expectations. But that’s a very important timeframe for us when the pre-market, pre-summer sales to the distributors who are stocking up will give us our best indication. So I would just say stay tuned.

Jon Tanwanteng: Got it. And then assuming industry have blended, do you expect revenue and margin growth in the next fiscal year?

James Perry: This is James, Jon. Good morning. Thanks for being on. As Joe said, we do expect revenue and EBITDA growth next year. We’re certainly working to continue to push margins. As we mentioned in the call, we focused a lot in the last couple of years on container rates. They’ve certainly come down, and for now they stayed down. We know how quickly that can move. Some of the other costs are still high, obviously; raw material costs, domestic freight, shipping freight out between our facilities and the customers, those costs remain high. But we’ve done a good job with our pricing, been able to retain that. As we said, we’re not back to our pre-pandemic margins. That’s always a goal. That goal is tougher, because obviously when costs are higher and you have to move pricing higher, margins are more challenging.

So we don’t have a firm view yet on margin guidance yet, per se. But we certainly — Joe and I and our business leaders have a goal to continue to push margin in the type of pace we’ve been able to recover so far.

Jon Tanwanteng: Understood. Thank you. You mentioned a little bit of a slowdown in the bidding markets and in architectural. Can you just talk about where you’re seeing that? Number one. And two, is it expected to continue? And kind of the impact — when you might see that in the P&L?