Greetings. And welcome to the CSW Industrials Third Quarter 2020 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 Instruction] As a reminder, this conference call is being recorded. It is now my pleasure to introduce your host, Adrianne Griffin, Vice President of Investor Relations. Thank you. You may begin.

Thank you, Christine. Good morning, everyone, and welcome to CSW Industrials fiscal third quarter 2020 earnings call. Joining me today are Joseph Armes, Chairman, Chief Executive Officer and President of CSW Industrials; and Gregg Branning, Executive Vice President and Chief Financial Officer. If you've 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 will now turn the call over to Joe Armes.

Thank you, Adrianne. Good morning and thank you for joining our fiscal third quarter conference call. As we prepare to discuss our strong quarter and year-to-date results, I was reminded that we are now in year five of our effort to build a diversified industrial growth company. Approximately 4.5 years ago, we recognized the potential value that could be created by combining the companies that form CSWI and our initial efforts to consolidate these companies under a single operating structure; share resources and best practices and to optimize our manufacturing footprint have definitively enhanced profitability. In the last year, we largely completed this first phase of this transformation, we are now in a strong position as we look to the future. As we continue along our path of maturation, we remain committed to investing in people, processes and systems necessary to drive long-term profitable growth guided by our compelling investment thesis. Through ongoing product introductions deploying technology and innovation and pursuing M&A, we are confident in our ability to provide growth and access our end markets we serve today and to deliver attractive risk adjusted returns to our shareholders. Before I begin a discussion of our results in end markets, I would like to acknowledge perspective concerns in these early days of understanding the potential global impact of the corona virus. At this point, we do not expect any material impact on our financial position, our results of operations. We would like to express our concern for those who have fallen ill and our appreciation to those who have vigorously responding to the people impacted by this virus. Like others with the supply chain relationships that include companies located in China, we are closely monitoring the possible economic impact of this virus. We sourced several products from Asia and specifically…

Thank you, Joe, and good morning everyone. As Joe mentioned earlier, our consolidated revenue during the fiscal third quarter of 2020 was $83.7 million, an 8% increase over the prior year period. Higher revenue was driven by increased sales in both our Industrial Products and Specialty Chemicals segments, primarily due to the 3.4% organic growth and acquisition-related revenue. Increased organic sales were driven by the HVAC/R, plumbing and general industrial end markets, partially offset by the architecturally specified building products and energy end markets. And looking at our quarterly segment level revenue, operating income and growth drivers; our Industrial Products segment posted revenue of $48.7 million, which grew 11.5% over the prior year period. Organic revenue accounted for 3.3% of the growth and was driven by increased sales volume in HVAC/R and plumbing end markets, partially offset by declines in architecturally specified building products end market. Our GAAP segment operating income increased 7.2% to $8.6 million, and there were no adjustments to GAAP results in the current or prior year within this segment. As we indicated on our last earnings call, operating income margins typically decreased in the third quarter as we experienced a 70 basis point decline over the same period last year, due primarily to negative mix in our architecturally specified building products end market. With respect to the negative margins, as we have stated in prior quarters, we would expect our operating income fall through on incremental sales in Industrial Products to be in the 25% to 35% range assuming normal mix. So, if you take that range of fall through and multiply it by our organic revenue growth, you can approximate the impact on the negative mix as we do not want to give a specific number on this due to competitive reasons. As I mentioned…

Thanks, Gregg. Solid foundation of year-to-date results positions us well for the balance of fiscal 2020 and into 2021. We will continue to drive integration and efficiency initiatives and to offer best-in-class products to serve our customers and to help their businesses grow and also to steward well the capital entrusted to us by our shareholders. Let me take this opportunity to thank all my colleagues at CSW Industrials who collectively own over 5% of our Company through our employee stock ownership plan and also thank all of our other shareholders for their continued interest in and support of our company. With that operator, we're now ready to take questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Jon Tanwanteng with CJS Securities. Please proceed with your question.

Good morning. This is [Brendan] [ph] on for Jon. So I wanted first go to the architectural and the mix issue that you called out. You talked about the delay -- construction delays, especially with the labor shortages right now as an issue, was that part of the mix issue as well? And was there something that was known in the backlog, was something external? And then looking out to Q4 and beyond, how do margins and scheduling look?

I'll start with that. This is Joe. And I'll let Gregg follow up. The issues of kind of customer-driven delays were certainly a factor here as they have been over the past few quarters. We are just seeing a number of delays and projects moving to the right. Some of those are related to labor shortages and again customer-driven completely out of our control. Secondly, there have been some execution issues there with respect to some rework that needed to be redone on some materials that came out of the facility and some installation issues that have impacted our profitability there. And then thirdly, I would say with respect to those, it's important to note they are limited in scope to really to primarily to one project and limited duration. And so again, we suspect that those will continue throughout the final fiscal quarter -- for our fiscal year, but not beyond that, and so again, limited in scope, limited in duration. And then thirdly, because of the health of our backlog and our confidence in our backlog, we made a management decision during this quarter not to reduce labor within our facilities and notwithstanding the slide to the right on some of these projects and some of the delays, and that is because we have a very strong backlog going into 2021, we need to be able to serve our customers. We don't want to lose any customers or damage our reputation for on-time delivery. And so, we made a management decision there to kind of bite the bullet during this quarter and the next in the long-term health of our business and really as an investment in our business going forward because of our confidence in the backlog and our future prospects for that business.

Yes. And this is Gregg. I'll add to Joe's comment from the delays. The delays were not due to us. They were due to our customers and scheduling and our ability to get on site and from the decision to not reduce our labor, that's skilled labor both inside the plant and with our installers. And so, when you look at our backlog, as I mentioned in my prepared remarks and Joe mentioned a second ago, we have -- our book-to-bill ratio has actually gone up over the last eight quarters from what it was a quarter ago. So the quality of our backlog and the strength that's out there is vital for us to keep that skilled labor force in place. And so, we wanted to make sure we helped everybody understand the impact of the slower sales in the quarter and the negative mix in the quarter, and that negative mix will also continue into fiscal Q4, but as Joe mentioned, we do not expect it to continue past that.

Okay, great. Thanks for the clarity. And then moving on to the energy, so you guys called out rig counts 20% lower. What are your thoughts on the oil fields and energy for 2020 or where do you think it can go?

Yes. This is Joe. I think that the weakness is likely to continue. Obviously, oil prices have come down a little bit more. We don't spend a lot of time trying to predict commodity prices around here; we can just react to the market. But I would say that energy is a small part of our business these days. The other thing I would say is that we do buy base oils. And so, there is some natural hedge there. I don't think it's anywhere close to one-to-one, but there are some benefits to lower commodity prices that we can take advantage of. So again, energy is a small part of our business. And so, we keep it in perspective, but we would not expect to have immediate rebound in that business.

And this is Gregg. To emphasize a small part of our business, when you look at our architecturally specified building products, our plumbing and our HVAC/R, that makes up over 70% of our total revenue. So then, when you're left with that other 30%, it's much smaller slices. And so while rig count is important to us and we do pay attention to it, it just is not a huge driver to us.

Yes. Okay. Makes sense. And then on the M&A front, are you seeing more or less opportunities? Have valuations come in at all? Is it still tough to find good deals out there?

But we have not seen any material change in valuations. But we have seen an up tick in our pipeline. And so, we feel very, very good about the robust pipeline that we see. I think it's as strong as since I've been here. And so, we're very pleased with the opportunities that we're seeing. And I guess some of those are intermediated; some are not. And we're very pleased with what we're seeing and confident that we're doing everything we can to bring in the opportunities to evaluate those according to our disciplined acquisition process, and we're ready willing and able to transact when the right opportunities present themselves. And I mean, the good news is that I mean, small acquisitions can make a major difference. As you see through the MSD acquisition and Petersen, that is still considered acquisition or inorganic revenue growth for us, that is meaningful. So I would just remind everyone that we spent $20 million in capital on those two small acquisitions, and they are meaningfully impacting our top line growth and our profitability. And so, it doesn't take a lot given the size of our enterprise. And so, we're very pleased with what we're seeing and we're optimistic that we're going to continue to augment our organic growth with these acquisition opportunities.

And this is Gregg, and I will also add. As we've talked many calls in prior quarters, cross-selling is important. The Petersen acquisition was a critical acquisition as it opened up geographic and other markets for us, as well as we provide markets that it did that the prior ownership didn't have and so, we are cross-selling there. That's part of the reason that our backlog has improved and why we've seen the up tick in book-to-bill. And we'll see the benefits of that in future fiscal years.

Great. That's good to hear. And then last thing, looking at 2020, I guess, what worries you the most or excites you the most at this point? Has anything changed since you last time you reported any opportunities or headwinds that have come up?

Well, I mean, obviously, the macro, there's a lot of uncertainty with respect to the macro, and it's completely out of our control. And so, I think that's what keeps me up at night the most. I'm confident in our business and confident in our ability to navigate through whatever comes our way, but we're not completely immune to the macro uncertainty or any headwinds. So I think that's the thing that bothers me the most. And most excited about, I'd go back, I think our acquisition pipeline is pretty compelling at this point and very, very pleased with that and optimistic that we will see some movement on that front.

Great, thank you.

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

Hey, good morning, everybody. It's Brian on for Joe. Thanks for taking my questions. Just maybe talk a little bit more about some of those execution issues. Could you just talk about -- have you implemented any processes or anything like that to kind of just make sure something like that doesn't happen again or is that something that maybe that new hire you guys addressed is going to be focusing on or just any more color on that would be helpful?

Yes. I mean, it's really both. Obviously, you're going to do a root cause analysis and figure out what's going on and make sure that those things get fixed early on, and we've done that. Scott does bring a world of expertise and experience through his background with ThyssenKrupp and literally having elevator mechanics out in the field that work directly for him. And so, he is a hands-on kind of manager. And so, he dove into this very, very quickly in addition to kind of reviewing the quality of the backlog to make sure that we can be confident in that. So our confidence today is based in large part upon that review. And so, yes, I think we've got our arms around it. It's just a single project that -- we got to get the project finished, but yes, we've addressed those issues, feel like the business is fundamentally very, very healthy. The backlog is strong. No reason the world to think, this is going to recur.

All right. Great. Appreciate that. And then maybe just on Specialty Chem, pretty strong margin performance. Obviously, so kind of where do you see that long-term sustainable margin tracking? And then also, it looks like you guys are coming up against a tough comp based on last year's fourth quarter. So how do you going to see that shape up?

Yes. This is Gregg. We're obviously pleased with the strong margins we posted in the quarter. But part of that was positive mix. Those margins are in line with what we've stated our long-term objectives are and will continue to be the case. And so, the key there, as we've said in prior quarters, is that we would expect on a normal mix to see fall-through between 20% and 30% on organic sales. And clearly, we had very strong fall-through in the quarter. Part of that strong fall-through was driven by the fact that we had an inordinate amount of strength in consumables. Those consumables in the end markets that we spoke of have much better margins and it's something that we are always concentrating on. It's what our core strategy is to provide more and more consumables because it extends the reliability and the life of the assets that our customers are using for. So, you're absolutely right. We're coming up on some tough comps just as we did here this year, in this quarter and last quarter for that matter. But we remain committed to our execution and performing in each of our businesses.

Okay. And then real quick, you just mentioned that the 20% to 30% flow through. So it's basically the 20% to 30% for Specialty Chem. And then I think earlier, you mentioned 25% to 35% on Industrial Products, do I have that right, just to clarify?

That is correct. And again, that's assuming normal mix if you do...

On the organic, normal mix.

Yes. If you do the math, you see that in Spec Chem in the quarter, we had 70% fall-through. So hence, our comment about normal mix and then in Industrial Products, we had just under 12%. So we had the negative mix there, so all things being equal. Yes, those are good benchmarks to or rails to work off of.

All right. Great. Thanks for taking my questions.

Thank you.

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. I just want to say thank you to everyone for participating in the call today. We look forward to speaking to you again at the end of our fiscal year. And again, thank you for your interest in our company and your support of us as we continue in our journey. 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.