Good morning, and welcome to the CSW Industrials Inc. Fiscal Second Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Adrianne Griffin. Please go ahead.

Thank you, Maura. Good morning, everyone, and welcome to the CSW Industrials fiscal 2023 second quarter earnings call. Joining me today are: Joseph Armes, Chairman, Chief Executive Officer, and President of CSW Industrials; and James Perry, Executive Vice President and Chief Financial Officer. 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 website 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.

Thank you, Adrianne. Good morning, and thank you for joining our fiscal second quarter conference call. Our record fiscal second quarter and record fiscal first half results demonstrate our successful efforts to drive top line growth, expand margins and increase earnings per share. Comparing our fiscal second quarter year-over-year performance, we reported 23% revenue growth, 29% EBITDA growth and 37% growth in EPS. These metrics clearly demonstrate our ability to generate leverage on incremental sales as gross margin growth outpaced revenue growth, operating income growth outpaced gross margin growth, and this trend continued through the income statement to EPS. Against the backdrop of macroeconomic uncertainty, our team continues to perform exceptionally well, combining operational excellence, disciplined capital allocation and a keen focus on customer service. In the current quarter, all 3 segments contributed to organic revenue growth of $25 million, driven primarily by the numerous price actions in the current and prior fiscal year periods. Due to the high-value nature of the products that we bring to market, we are able to realize positive pricing of our products. Our story this quarter is one of building on commercial momentum created in prior periods, founded upon our highly differentiated products and leading positions in the end markets that we serve. During the fiscal second quarter, we closed the previously announced acquisitions of Cover Guard and AC GUARD. And subsequent to quarter end, we consummated the acquisition of Falcon Stainless. The acquired product lines expand our offerings sold into our profitable HVAC/R and plumbing end markets. Through these bolt-on acquisitions, we deployed $58.1 million of capital at a valuation of 6.6x EBITDA, which was funded through cash on hand and borrowings under our existing credit facility. As a reminder, in December, we closed the Shoemaker acquisition, which expanded our GRD offerings sold…

Thank you, Joe, and good morning, everyone. Our consolidated revenue during our fiscal second quarter 2023 was $191 million, a 23% increase as compared to the prior year period, driven by price and contributions from acquisitions. Consolidated gross profit in the second fiscal quarter was $81 million, representing 28% growth, with the incremental profit resulting primarily from sales growth. Gross profit margin improved to 42% compared to 41% in the prior year period due to the cumulative benefit of price actions in TRUaire Vietnam COVID expenses of $1.2 million incurred in the prior year period, that did not recur. I'll note that we did not call out any adjustments to our reported earnings in the current fiscal quarter. Consolidated EBITDA increased 29% to $44 million as compared to the prior year period. Consolidated EBITDA margin improved to 23% as compared to 22% in the prior year quarter, driven by sales growth, which outpaced incremental expenses. Reported net income attributable to CSWI in the fiscal second quarter was $24 million or $1.57 per diluted share compared to $18 million or $1.15 in the prior year period. Our Contractor Solutions segment with $130 million of revenue accounted for 68% of our consolidated revenue and delivered $27 million or 26% total growth as compared to the prior year quarter, comprised of organic revenue growth of $16 million and inorganic growth of $11 million from the Shoemaker, Cover Guard and AC GUARD acquisitions. Organic growth resulted from the cumulative benefit of implemented pricing initiatives, partially offset by a slight decrease in unit volumes as compared to last year. Strong net revenue growth as compared to the prior year period was driven by the HVAC/R architecturally specified building products and plumbing end markets. Segment EBITDA was $39 million or 30% of revenue compared to $32…

Thank you, James. In the first half of fiscal 2023, we delivered record revenue of $391 million, representing growth of 23%. Operating leverage on this growth drove 25% growth in EBITDA and 31% growth in EPS. In light of the strength of our fiscal first half and including our recent acquisitions, we now expect a year-over-year revenue growth rate of approximately 20% with an EBITDA margin of approximately 22% for the full year. We remain committed to operating discipline that will maintain our profitability, and we will assess opportunities for potential cost reductions as well as further pricing options. This quarter, I began reviewing all new and replacement hires to ensure that the position is warranted in the current environment, and we are maintaining our disciplined approach to monitoring our costs across the company. We are expanding margins and driving cash flow conversion. We are confident in our near-term and long-term opportunities for disciplined capital allocation, which are 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, we have consistent -- in the past, we have consistently delivered outstanding financial results, and we will utilize that same approach for the remainder of 2023 and beyond. With respect to our acquisition pipeline and plans, as we sit here today, we are focused on integrating the 4 acquisitions that we have completed in the last 12 months on working capital efficiency and operational excellence. We do not currently expect to close any acquisitions in the next few months and thus, we expect to delever through the repayment of debt by growing our EBITDA. Earlier this month, we welcomed Danielle Garde, who joined our executive leadership team in a newly created Chief People Officer role. Danielle brings extensive experience building teams and a demonstrated track record of organizational development. The creation of this role recognizes the global growth that we have realized and will continue to pursue. Danielle is personally dedicated to CSWI's distinctive employee-centric culture and she affirms our intention to be an employer of choice. My colleagues hear me say this often, at CSWI, we must, and we will succeed. There is no other option. But at CSWI, how we succeed matters. Achieving these outstanding year-to-date results demonstrates our commitment to being good stewards of your capital and our goal of delivering long-term shareholder value. As always, I'd like to close by thanking all of my colleagues here at CSWI, who collectively own approximately 4% of our company through our employee stock ownership plan as well as all of our shareholders for your continued interest in and support of our company. With that, operator, we're now ready to take questions.

[Operator Instructions] The first question is from Jon Tanwanteng from CJS Securities.

My first one is, could you talk a little bit more about demand in each of your end markets and where you're continuing to see areas of strength and maybe where you're starting to see areas of weakness. You mentioned inventory reductions in your contracted Solutions business. Maybe is that -- is that based on sell-through? Or is it truly inventory management? Just a little more color there would be helpful.

Yes, Jon. I'll let Joe in as well, but I'll start with the question. Looking across our segments, you look at Contractor Solutions, we continue to see good demand. Obviously, we're entering kind of the seasonality where things are a little bit lighter. So the next couple of months, it's normal that we would see that. We're seeing a little bit of destocking out there. I think everybody is feeling more confident about the supply chain. So we see and hear distributors talk about a little bit of destocking. We're in the same mode. Obviously, with more confidence in the supply chain, things are getting here a little more quickly. We feel better about that. We see a little bit of destocking ourselves. As Joe mentioned, we always have prudent working capital management. But with higher interest rates, there's a higher carrying cost as well. So we've got an intense focus on that. Higher cost of carrying goods is important to us and meaningful, so we're watching that carefully. So we do anticipate in the coming months seeing inventory come down a bit in terms of kind of days on hand on what we call weeks in stock. Now obviously, as you get into the busy season, kind of that March time frame, you're going to need to stock back up. So we have to really plan carefully. Some of what we're going to be selling in March is already on the water. It takes a few months for things to get from our facilities in the Far East over to where they need to be to sell. So it's a moving target, but we've spent a lot of time with our teams. In fact, just yesterday, we were talking about inventory with the Contractor Solutions team. They're doing a…

The only thing I would say is James did a good job describing the backlog on EPS, but we have backlog in all 3 of our segments. SRS has maintained a very healthy, very consistent backlog in their business for the last 6 months or 8 months, and that remains at a similar level, so no change there. And Contractor Solutions has had a backlog now, which is larger than normal, and they've been able to work that down some. But we still have shortages in some products, maybe a little bit more inventory than we want in other products. But our focus is on really March time frame. When the season begins again, the high season for HVAC restocking, if we've got the right levels of inventory in March, that's key to customer satisfaction, the key to making sure that we don't miss a sale and so we'll be working very diligently, highly focused on rightsizing the inventory, both on an addition and subtraction basis to get the right inventory by March because as James said, we're going into a little bit of a slower season for us, and it's the right time to get those inventory levels right sized.

That kind of dovetails into my next question a little bit. Joe, you mentioned 20% growth, 22% EBITDA margins. How confident are you in those expectations? Or how much cushion is there maybe just given that you're seeing some slowing in some areas, maybe more uncertainty than others, especially since a lot of that is going to be loaded in the end of the March quarter when you see the restocking season.

Yes. Traditionally, we always are concerned about March. That's a big month for us, and it's important to get the orders in and execute against those orders. But we feel good about that, Jon. That's an increase from where we started the year. It's an increase from where we were last quarter. And so we're pretty sober about those things. And so we feel good about those numbers. We feel like we've got good visibility for the next 6 months. We spent a lot of time. We do midyear reviews. We just completed those with all 3 business segments, and I think we've got a real -- our teams have a really good handle on their businesses for the next 6 months. And so we feel good about those expectations.

And then just one housekeeping question. The interest expense in the quarter was a little bit higher. Was that completely the underlying base rate increasing? Or was there a bigger intra-quarter drawdown? Number one. And number two, were there any M&A expenses that maybe you didn't call out or at back just because you --

I'm glad you pointed that out. Yes, interest expense, obviously, rising rates and you had another jump yesterday of 75 basis points. You'll see that again. So I want to be sure we continue to factor in those rates are up because we're on a variable rate with our revolver. We were down a little in the quarter, quarter-over-quarter, but the acquisition we made of AC GUARD and Cover Guard was early in the quarter. So the debt that we took down for that kind of we paid for that whole quarter at that higher interest rate. So that's what it is. And I think the run rate that you saw this last quarter, you need to consider rates going up a little bit more, and we borrowed for the Falcon acquisition right after quarter end. So you're going to see as we gave you a leverage number up a little bit, so a little higher debt, a little higher interest rate, However, we have the opportunity to offset that. Timing will dictate when we can do it, as we said in Joe's remarks, right now, we first see delevering a little bit. Some of that's EBITDA growth, that didn't affect interest expense. Some of that is we intend to pay down some debt in the coming months, but when that happens, not sure. So I think interest rates going. up and our interest expense going up is a reasonable expectation. In terms of acquisition costs, yes, we didn't call that out. It wasn't big enough to adjust earnings like we did when we did TRUaire. We really try not to do adjustments if we don't need to. It was about $0.03, Jon, in the quarter about $600,000, which is about $0.03 on the M&A expenses we had for the Cover Guard, AC Cover Guard, the work we had done to date on Falcon during the quarter. So hopefully, that helps you model a little bit.

The next question is from Julio Romero from Sidoti.

On the SRS segment, are the different end markets trending?

Yes. I think we're seeing positive end market demand across the board. The energy market remains very strong. That's very important to us. With the rig counts where they are, with the oil prices where they are, and that's a very important market for us. I think as we look at the industrial markets and markets continue to do well, rail shipments continue to be good, and that's an important market for us. I think if you look across the board, Joe, we're seeing good demand. As Joe mentioned, we had mid-year reviews with that group and had their executive team in the room with us for a few hours last week, and we really saw a lot of optimism. That team, in fact, has overseas had a big conference this year and that this week, and that's going really well, too. So we're seeing global demand, but domestically, that energy market is a big driver for us and very important.

And on the CS segment, can you guys talk about the volume trends that you guys are seeing?

I'm sorry, ask again, Stefan?

Can you talk about the volume trends on CS segment?

In terms of volume trends, this quarter, like we said last quarter, we're down just a [hair] quarter-over-quarter. That would indicate a bit of the slowdown potentially. But last year, you just had a really strong demand. It was a pretty hot summer. You were still working through COVID. There were still a lot of folks at home. You have less of that this year. So volumes are down ever so slightly again this quarter, low single-digit percentages. So we still feel good about that. So the growth that we had year-over-year was the acquisitions, which obviously helps volume in general and pricing initiatives. We've had several pricing initiatives, the last one being at the beginning of this last quarter. So you had the tailwind of pricing there. But volumes have hung in there well. Again, you're working against some pretty tough comps from last year on a same-store sales basis, so to speak, so down ever so slightly.

Now on your recent acquisitions within the CS segment, can you guys talk about what attracted you to Cover Guard, AC GUARD and Falcon, and the strategic rationale behind them?

Well, let me say broadly, Stefan, we have said that Contractor solutions, HVAC and plumbing end markets has been our highest priority for M&A. And so consistent with those themes, these acquisition opportunities arose. And we've been pursuing the Falcon acquisition for literally a decade. Institutionally -- James and I and others weren't here, but others started those conversations. Really, it's about value to the customer, which should be connoted in gross margins and growth opportunity for us. And so like a lot of the products that we are able to acquire and put through our distribution, we can provide broader distribution. And so the accretive opportunity for us is pretty significant. And so high-quality products that bring significant value to our customers that would benefit from broader distribution is a great recipe for us. And then the last thing I'll say is very attractive valuations, as you saw. Acquisition multiples oftentimes don't move in dramatic fashion, but these were very attractive valuations for us, and we're very pleased to get these deals consummated.

So could you please give us like historical organic revenue trends for those 3 businesses?

Not only acquisitions, they've had nice growth. But what was really important, as Joe talked about, is being able to put their products through our distribution channel, we think accelerating the growth they've had in the past is a good opportunity for us because they had some regional distribution, a little bit nationwide, but very regional, given what they were able to do. And we've got the opportunity here to really see some nice organic growth from those acquisitions.

The next question is a follow-up from Jon Tanwanteng from CJS Securities.

I just wanted to drill down a bit on the energy business, unintended there. But where is that as a percentage of revenue within SRS today? And how does it compare to prior peak or trough levels first of all? And then second, I guess, what is the expectation there going forward, assuming that OPEC is cutting production, you can't keep releasing from the SPR forever. Just help us think of what that business looks like going forward.

Yes, Jon, I'll defer to James, but I don't think we've been providing those kind of end market data points like we used to. But I would say that certainly, you've seen a meaningful increase here from the lows. I don't know -- certainly, the rig count, which is a great proxy is not anywhere close to where it was a few years, ago and may never get there. There's fewer rigs being used for multiple wells now, and the whole math on that has changed. But I would say demand is really strong, both domestically and internationally, and we think that it could even get stronger. And so, we're very positive on that business. It doesn't always move in sync with our other end markets. At this time, it is moving in sync. And so all of our end markets are on the uptrend, as James said. Energy is a little bit of that swing in market that really makes the difference here for us. And that's an important part of the profitability. But the increased volumes overall and the increased volumes from the Shell JV are also contributing nicely for overhead absorption. And as we've talked about, the -- that's a higher fixed cost business than our others. And so volume really matters there. And so as we continue to see strength in the energy market, we expect to see continued outstanding results out of that business for all of those reasons.

Could you break out the expected contribution from the 3 acquisitions in the second half of this year on a revenue or EBITDA basis?

Yes. We're not providing that now. As we go through each quarter, we'll give you the inorganic growth. I think you have -- we said in the second quarter, it was $11 million of revenue. Shoemaker was obviously a part of that, which has been with us since last mid-December. And then Cover Guard and AC GUARD came in early in the quarter, as I said, so they added a little bit. These were on the smaller side. In total it was $57 million of acquisitions, but you're going to see contribution. You're going to see immediate accretion and you're going to see revenue contribution. But can as we go through each quarter, we'll give you the inorganic growth, and you'll be able to look back and see what that is. As we enter the January, February, March quarter, Shoemaker won't be inorganic anymore, and we'll remind you of that. So you'll get a good sense of that as we go along, but we're not prepared to give a pro forma of that. But I will say, to Joe's comment and the kind of raise in guidance, so to speak, of 20% revenue growth for the year and 22% EBITDA margin for the year. The strength of the first half and the acquisitions contribute to that. So that tells you that these acquisitions are accretive, obviously contribute to growth and are very positive for us in full fiscal year context.

And just a question on supply chain and inflation and shipments. Just one, did you miss any shipments in the quarter and are you expecting to close that gap going forward? And number 2, just with supply improving, are you seeing that cost coming down as well, whether it's freight or components or other inputs?

Yes. Good question, Jon. I'd say the raw materials and those things have come down a little, not dramatically. As I mentioned earlier, the time on the water, especially, and that's what's most important to us with that question has come down. You were 12 weeks before. Now you're anywhere from 6% to 10% depending on which ports you're going to. The West Coast is obviously getting things a little more quickly. But as we ship things to Houston or the East Coast, it's a little longer, and that's always going to be the case. I'm sure you've seen freight rates decline dramatically. We saw freight rates in the 20,000 plus a container for a while. Now you're seeing things in the low thousands to the West Coast. What you see published is kind of that Shanghai to Long Beach rate, and we're coming from China and Vietnam into Long Beach and then other parts. And obviously, as you get further around the states, as I mentioned earlier, Houston or the other ports, you're in kind of the mid to a little bit higher single digits. So a blended rate is not that published straight UC. What's important, though, and I know we've talked about this before, Jon, but it's -- your question tees up a great reminder to you in our investment community is when you see that rate, if we put something on a boat at a few thousand dollars, it's not going to flow through the cost for several months, say, 3 months or 4 months because the time on the water, then the time in our warehouse to the time we turn it into revenue. It's a 3, 4, maybe even 5-month lag depending on the product. So those rates coming down dramatically in the last couple of months. You're now going to start seeing that tailwind here kind of end of this quarter and into our fiscal fourth quarter, which, again, to Joe's point, gave us confidence in that 22% EBITDA margin because we see costs coming down, but it takes a while to flow through from when you see that CNBC headline about freight rates coming down this week.

That was the last question. I would like to turn the conference back over to [indiscernible] for any closing remarks.

Great. Thank you, Maura. Thank you, everyone, for joining us for our conference call today. We look forward to talking to you again soon. Take care.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.