Greetings. And welcome to the CSW Industrials Third Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tom Cook. Thank you, sir. You may begin.

Thank you, Kristine. Good morning, everyone. And welcome to CSW Industrials’ fiscal third quarter 2019 earnings 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 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 for joining our fiscal third quarter conference call. We are going to begin today with a brief recap of our results for the quarter. Next I will provide some segment highlights and a review of each of our end markets. Then I will hand the call off to Gregg for a closer review of our financials. I am pleased to report that we had an exceptionally strong third quarter, highlighted by consolidated revenue growth of 12.3%, all of which was organic and a 44% increase in adjusted diluted earnings per share to $0.46, which was driven by higher revenue, effective cost controls and operating leverage. Higher revenue resulted from growth in both of our Industrial Products and Specialty Chemicals segment and was led by stronger sales in HVAC, architecturally-specified building products and general industrial end markets. GAAP earnings per share increased to $0.39 per share compared to the prior year period of $0.17 per share. In our Industrial Products segment, sales were up over 15% to $43.7 million, as we experienced continued strength and demand for our HVAC products, and a strong contribution from architecturally-specified building products. Segment level operating margins remained at a healthy 18.5%. Although, that was down 80 basis points compared to the prior year, as a result of higher performance related compensation expense on stronger results and spending on an ERP upgrade. We are very pleased by this result and looking forward we expect to continue to grow at a pace in excess of our end markets, as we bring new innovative products to the market and capture incremental share, as demonstrated by our 6.6% organic revenue growth rate on a year-to-date basis. As we have said in the past, we do experience volatility quarter-to-quarter as a result…

Thanks, Joe, and good morning, everyone. Consolidated revenue during the third quarter of 2019 increased 12.3% to $77.5 million. Higher revenue was driven by increased sales across both our segments, primarily in the HVAC, architecturally-specified building products and general industrial end markets. Looking at our segment level revenue and operating income, Industrial Products segment revenue increased to $43.7 million, a 15.3% increase over the prior year. This increase was driven by higher sales volumes in the HVAC, plumbing and general industrial end markets. GAAP segment operating income increased to $8.1 million, a 10.1% increase over the prior year. The increase in operating income was driven by higher sales, partially offset by increased performance based compensation expenses, and spending and upgrading our ERP systems. As a percentage of sales, third quarter GAAP operating margin decreased 80 basis points to 18.5%, compared to the prior year period of 19.3% due to the spending on our ERP upgrade. To Specialty Chemicals segment revenue increased to $33.8 million, an 8.7% increase over the prior year. Increased sales were driven by higher volumes in general industrial end markets and to a lesser extent architecturally-specified building products. Our GAAP segment operating income increased to $4.6 million, a 17.9% increase over the prior year. The increase was due to savings from prior restructuring and realignment activities, and leverage from increased sales, partially offset by performance-based compensation expenses. As a percentage of sales, our third quarter GAAP operating margin increased 100 basis points to 13.5%, compared to the prior year period of 12.5%. Now turning back to our consolidated results, our gross profit increased to $34.2 million, compared to $30.2 million in the prior year period. Our gross margin increased 40 basis points to 44.2%, compared to 43.8% in the prior year period driven by the sales leverage.…

Thanks, Gregg. We only have two months left in our fiscal year, but we are very pleased with the strong execution across our operating units in the third quarter, we are also pleased with momentum in our business. I believe we are well-positioned to conclude a successful fiscal 2019. We are poised for incremental progress and value creation in the year ahead. Let me take this opportunity to thank all of my colleagues at CSW Industrials, who are doing such a fantastic job as we continue to serve our customers and steward well the capital entrusted to us by our shareholders. Thank you for your interest in CSW Industrials. Operator, we are now ready to take questions.

Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Jon Tanwanteng with CJS Securities. Please proceed with your question.

Hi. Good morning. It’s Pete Lukas for Jon. You touched on it in your comments. I just want to make sure for why margins were down despite higher revenue in Industrials, was that just the ERP upgrade or was that anything to do with mixed input costs or something else there?

Yes. This is Gregg. It was primarily due to the ERP upgrade. We did have, as I mentioned, the higher compensation based -- our performance based compensation expense. But if you were to take out just the ERP and ignore the compensation based, performance based compensation, we would have actually been up 20 basis points. And then further clarity on the ERP, we are in the midst of a four-year period to move all of our Industrial businesses into one general platform and this being the front end, the way the accounting rules work there are -- you have to expense some costs on the front-end, the majority of this will roll through our normal CapEx and so we don’t expect it to be an ongoing expense, which is also why we didn’t call it out as a onetime.

Helpful. Thanks. And any update on the price of metals for architectural products?

Yeah. This is Gregg again. I would say that, we have seen that moderate it, but more importantly, where we did see the increases early in the year, we put price increases in place for tariffs and metals in general. And so as you saw with our gross profit margin were up year-over-year and so we have been able to cover the price of commodities in general.

And then, last one from me, just as far as what the M&A environment looks like in terms of valuations you are seeing out there, number of deals, just general tone of the market?

Yeah. The tone of the market remains pretty strong. However, we are seeing some very interesting opportunities on some product line extension, smaller acquisitions that would be strategically important to us, but not large in size. But I would say valuations are still high. We continue to have a disciplined approach, but we are seeing some interesting opportunities in small product line extension opportunities.

Very helpful. Thanks. I will jump back in queue.

Thank you.

Thanks, Pete.

Our next question comes from the line of Joe Mondillo with Sidoti. Please proceed with your question.

Hi. Good morning, guys.

Hi, Joe.

So just a follow-up on the margin question at Industrial segment, going forward what kind of incremental margins do you sort of think about considering sort of the ERP costs and I am not sure how sort of this incentive based comp sort of plays out. But I think, historically, you have talked about around maybe 30% incremental margins this quarter. We were I think below 20%. So how do you sort of -- how should we sort of think about that going forward?

Yeah. Joe, this is Gregg. I think, again, we still believe the fall through should be in the 30% based on normal mix this quarter from a year-to-year, fall through. Certainly, the impact of the ERP drove that fall through as you mentioned below 20%, if it hadn’t been for that, we would have been well above the 20%. And then the other thing is we -- if you recall, looking at proxies and information in the past, we have been underperforming on performance based compensation and so that’s quite honestly bolstered some of the margins in the past. And then this year, we are doing better and so you see an effect going both directions as a result of that. But more importantly again…

Okay. So…

… to your underlying question, the 30% is still a good number.

Okay. Is this $400,000 expense on ERP, that’s an ongoing expense, right? And is that -- is this the first quarter that we have seen that, so another words, if the next three quarters going to be sort of a headwind related to that that would weigh on margins?

No. Where -- my earlier comments is, the way the accounting rules work is, without getting into the technical aspects, the beginning of a project does not get capitalized, if you will. There’s a lot more technicalities than that. But -- so that gets expenses. And then going forward, the majority of the cost will end up in capital, which will be put us more at the top end of our capital range that we have talked about in the past. So we don’t expect this to be any large ongoing headwind from an expense perspective, might be small moderation, but nothing like we saw here in the first quarter.

Okay. And then just in terms of the performance based comp, is this sort of an inflection to where the next couple of quarters maybe a little bit of a headwind or is that sort of reset after this quarter, so going forward like you said, incremental should be sort of back to normal?

Yeah. Yeah. I think that we will see a minor headwind for both segments, but nothing like we saw this quarter.

Okay. At the HVAC part of the business. Could you talk about that piece of the business, I was -- and I am a little surprised that it is so strong. Specifically, given sort of the housing data, I mean, existing home sales continue to weaken. I would think that kind of performance in that market would affect your growth rates a little bit, but it doesn’t seem like it has. So could you talk about, why you think you are seeing such strong growth and I know you mentioned that this quarter did see a good comp in terms of maybe weather, but could you just talk about sort of the overall trends that you are seeing there?

Yeah. This is Joe. We did have an easier comp for the quarter due to weather last year. But we really think this is -- as I said in my prepared remarks, I mean, we have got repair and replacement, it is a large part of our business and it’s not totally dependent upon housing starts. I would say that the installed base is really important for us and as the installed base has grown dramatically over the last few years, then that’s good for our business. We also have innovative products, the ductless mini-split is an innovation here in the U.S., has been popular in other parts of the world, but that’s primarily a refurb or remodel product that people, if you add a room and your kind of central system is unable to be balanced properly or just isn’t getting -- if you finish out an addict or something like that, it’s just not getting the kind of airflow that it needs, the ductless mini-split it’s a perfect solution to that problem. And so I think it’s a number of those factors, and then again, the innovation of this -- in this end market is really a big driver, efficiency, safety, environmental concerns as all provide opportunities for innovation and we are creating kind of new product categories as an industry, not just us, but as an industry, creating new product categories and new product lines that really it’s an adoption issue. For instance, the new surge protectors that we introduced at the trade show. I mean, theoretically, every air conditioning unit, every furnace and every home and commercial building in America or in the world have one of those or at least, yeah, each unit should have one and as we know homes, oftentimes have multiple units. So that’s going to be an innovation effort for us, an adoption effort for us in the industry. It’s not that there is just 3% growth in an existing market and we are fight -- killing each other for share, there is a big greenfield opportunity there.

Okay. Great. And then on the architectural building product side, could you just talk about the backlog of projects that you have there and sort of how does the outlook for the next few quarters sort of compare to what you have seen over the last year or so?

Yeah. This is Gregg, again, Joe. Our backlog remains strong. We are up significantly from the end of last fiscal year and so we are well-positioned, as you know, that is more of a backlog based business and so it really comes down to execution. And then to a certain extent weather and availability of labor by the trades, but we are in good shape, you may recall, last quarter, we mentioned a couple of nice projects that we won that will ship out or start -- we will start recognizing revenue, if you will, in fiscal -- at the end of -- in Q4 of this year and then next fiscal year, and so that bodes well for us.

Okay. And just, overall, Industrial segment, could you talk a little bit about pricing and how that’s trended over the last few quarters and looking forward, I know some commodity prices have come back a little bit, does that spread between pricing and cost. Is that a benefit or does that affect you at all, so just talk about like pricing versus volume that kind of thing?

Well, Joe, this is Joe. I will start and Gregg can follow up. But I think we have been pretty aggressive on price increases to protect our margins. And generally speaking in the tariffs, as the tariffs and some of the raw material costs have go -- have moved up, our competitors have been in a similar situation. So that’s made it a situation where we could raise prices, we just need everybody to be disciplined in that regard. But we feel like we have stayed ahead of the curve on that effectively and we are pleased with the operating teams and how they have done that. I think that, as some of these raw material costs fall, we do not necessarily have to give all that back and so that will be the next kind of level of work for us and will be diligent in trying to maintain these margins and it’s important for us to do. Gregg?

Yeah. I would also add. Joe, this is Gregg. When you look at to your question on the volume and price, certainly we saw volume too, it wasn’t all price otherwise we would have seen our gross margin tick up a lot more than it was than it did. So we have seen the cost primarily in the form of tariffs as those have come through, but our price increases that we put through earlier this year and we -- in some cases, we put through more than one price increase to make sure we protect our margins as we committed to our investors at the end of last year is that it’s our job to protect our margins. So we have been fairly strategic in looking at our price increases and trying to pay attention to what’s happening within the general markets, the demand for our products, value selling our product et cetera. And so, as Joe said, I think, as we are hopeful tariffs will go away at some point and then it’s our opportunity and our job to try and mitigate any decrease in price at that point and capture more higher margins but that will -- we will cross that bridge when we come to it. But we have been very effective in pushing price in the face of increased cost through tariffs.

Okay. Would you say at least at the Industrial segment, a good portion of the growth over 50% is on price?

I wouldn’t, no.

Okay.

Again it’s -- the pricing is strategic and so in some cases we have been able to push more price through than others. And then the other thing, I would say is, if you think back some prior conversations, I believe we have is that on the building product side, because it is a backlog based business that those projects are bid well in advance and so their price doesn’t really affect those projects until future bidding, and so that’s the other reason I would say that it’s not over 50% as price related.

Okay. I wanted to ask about the seasonality at least on the margin side of the Specialty Chem segment. I just want to verify last fourth quarter in 2018, you saw a fairly weak quarter relative to the rest of the year, but I believe there were some issues there and so I just wanted to make sure sort of how to think about that on a comp basis this year. Is that correct that fourth quarter last year was sort of an anomaly and after you did certain, I mean, you made some consolidated couple of plans in Europe and there has been changes since then. So how do I think about fourth quarter relative to the rest of the year sort of going forward?

Yeah. This is Gregg, again, Joe. You are right. There were some anomalies. We have consolidated some facilities in Europe. We have finished -- effectively finished the small fill line. You may recall we have talked about that and so what we said, as we exited Q4 and had our call at the end of last fiscal year, we believe that was the low watermark, if you will, for our margins in that business and that we would trend this year up to a mid-teens margin, which we have been doing. Clearly where we do see seasonality is more in fiscal Q3, from a sequential standpoint the margins in that segment were down from 16.7% in fiscal Q2 to the 13.5% in fiscal Q3 and volume makes a big difference there just as it does in our Industrial Products segment, as we are seasonal with HVAC and plumbing products that go through both segments.

Okay. Perfect. And then last question for me and this -- I don’t know if you mentioned this in your prepared remarks. But could you update us on sort of what you are thinking about CapEx for this year and if you have any comments for next year and then also anything -- I know you have been working on sort of ways to increase your inventory returns, and I am just wondering sort of on working capital, what your thoughts are for that?

Yeah. CapEx, we continue to be in the 1.5% to 2% range of sales and we expect that to finish this year somewhere near that. As we go into fiscal 2020 and beyond with the ERP project, we will probably be on the higher end of that range and maybe a tick over, we will give more a better general range as we finish the fiscal year and we complete our budgeting cycle. But I would say as we go forward we will tick up a little bit because of the ERP project. And I forgot your second part of the question.

Cash.

So just working capital, how you are thinking about like use of cash for that?

Yeah. So working capital continues to be a focus for us. We did see -- you will see in the cash flows, a nice improvement in our receivables. Our receivables are down roughly -- our DSO is down about five days from the end of last fiscal year, fiscal 2018 and so we have made a concerted effort there. Our DPO has remained flat and our inventory returns have remained flat. Part of the reason the inventory returns have remain flat is two-fold. One, you may recall in our comments at the end of fiscal Q2 that we did take on some additional inventory to try and protect ourselves from tariffs, some of that inventory is still on hand. And then as we build for our fiscal Q4 coming out of our low seasonality of Q3 that drives inventory up, but it remains a very high priority for all of us here at CSWI.

Okay. Great. Thanks a lot. I appreciate it.

Thank you, Joe.

Thank you. We have reached the end of the question-and-answer session. I would now like to turn the floor back over to management for closing comments.

Great. We just want to say thank you to everyone for joining us. Appreciate your support, your interest in CSWI and we look forward to speaking to you at the end of our fiscal 2019 year end. So thank you.

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