CSW INDUSTRIALS, INC. Q2 FY2025 earnings call

• Record quarterly revenue of $228 million, cash flow from operations of $67 million, EBITDA of $61 million, earnings per diluted share of $2.26, and net income of $37 million. • Gross profit margin expanded to 45.6% and EBITDA margin to 26.7%. • Issued 1.265 million common shares in a follow-on equity offering, raising $347 million, paid down all revolving line of credit debt, ending the quarter with no debt. • Added to the S&P 600 Small Cap Index. • Cash flow from operations was a fiscal second quarter record of $67 million, 49.5% growth over prior year. • Each segment delivered strong results: Contractor Solutions with 70% of revenue, Specialized Reliability Solutions with revenue growth driven by unit volumes, Engineered Building Solutions with revenue increase from backlog conversion.

The three business segments each delivered impressive results. The Contractor Solutions segment had $159 million in revenue, accounting for 70% of consolidated revenue, with $18.9 million or 13.5% total growth compared to the prior year quarter. The Specialized Reliability Solutions segment revenue increased by 5% to $38.5 million, with segment EBITDA of $7.1 million, a 13% increase from the prior year period. The Engineered Building Solutions segment revenue increased to $32.7 million, a 12% increase, with segment EBITDA growing 15% to $6.6 million.

• Management didn't give specific guidance for next fiscal year yet. • Mentioned demand has been good across the board, teams have responded well, picked up market share, and booking trends are solid in some segments. • Noted that while margins may fluctuate, there's nothing seen indicating unusual factors in the quarter or first half that would prevent maintaining strong performance going forward.

• Ocean freight costs are a headwind for second half COGS, with higher costs expected compared to the first half. These costs, if remaining elevated, can be offset by pricing actions as justified by the company's pricing power.

Q: Congratulations on another really nice results. I was wondering if you guys could talk about the sustainability of the strength that you've seen in the first half of this year? Maybe as we come to the next -- the same period next year, do you think you can keep those margins that close to 28% EBITDA level? What were the sustainable versus the 1x drivers of what you saw?

A: Jon, thanks for being on and your coverage of us. As always, we appreciate the support. Yes, I don't think we see anything that tells us that there was anything unusual in the quarter or in the first half necessarily. There's always some ins and outs. We don't give guidance, so we've not started talking about next fiscal year quite yet, but demand has been good across the board. Our teams have really responded well to that. We've picked up market share across the portfolio. We're booking good projects in EBS. Our SRS team continues to benefit from higher volumes and absorption in the manufacturing facility and continuing to improve in operations there. And of course, the Contractor Solutions team continues to find good acquisitions, which -- as we always say, acquisitions will fuel future organic growth, so as we get those products into more store fronts across the country into more of our distributors' hands, we continue to have great distribution relationships. And we're picking up operating leverage as we grow the top line. So while we always say that we want to caution people of assuming the margins will continue to grow given the strong levels they're at, there's nothing unusual about the first half of the year or the quarter that we would see that would change this time next year.

Q: You're flush with cash now. What are the expectations for that? How does the pipeline for M&A look like compared to where it was last quarter? Just help me understand if there's more larger or more opportunities out there and if you raised that cash specifically for a targeted acquisition or something else that was going on?

A: Yes. No, thanks, Jon. That's a great question. Yes, obviously, as a result of the successful equity offering, we do have no debt and cash on our balance sheet. We did not raise that capital in light of any particular acquisition that we had identified. It was really more of a war chest for us to be in the position so that we could exploit attractive opportunities that came about. I would say that our pipeline continues to be very robust. We're very pleased with the level of activity, with the opportunities that we're seeing, and we're pleased with the inbound calls that we're receiving now as a result of this. And then I would just remind you that we found ourselves in this position about 4 years ago when we had no debt and cash on our balance sheet, and that is when we were able to consummate the acquisition of TRUaire, which has been our largest and most successful acquisition to date. And so we like being in that position. We like being able to provide speed and certainty to a seller. And we think it helps us in actually capturing those opportunities and also helps us and is attractive to the seller from a valuation standpoint that we can move quickly and that we don't need to go to the market to raise financing. So robust pipeline. We intend to put this capital to work, but we will always stick to our disciplined approach and apply the same sort of rigor that we always have on evaluating these opportunities and the risk-adjusted return analysis will drive our decision making.

Q: Could you talk a little bit more about PSP and kind of what that business does? It seems a little bit outside your traditional verticals. Maybe talk about the financials of the business, the prospects going forward? And kind of does that open up new pathways or doorways to M&A to add on to that type of business?

A: Yes, Jon, this is James. Thanks for mentioning that. I’m really pleased with the PSP acquisition. Just like Dust Free earlier in the year, this is a company that we had partnered with and been distributing their products for a while. And once again, that model turned out very well for us. We learned the product, our sales force and folks understood the product, understood the industry. We were doing a little bit in the electrical space. We’ve always said that kind of HVAC is obviously the big part of it, plumbing is there and electrical is there in a small way. This gets us much more seriously in the electrical end market. So it allows us to run through the same distribution channels that we do with our other products and now put PSP through even more distributors. And so the owner of that business is a great innovator, continues to work with us and will for quite a while, innovating new products. So these are surge protection devices that can protect your HVAC unit. So when the contractor comes out to your house and installs a new unit or does a repair, literally can add a surge protector unit for a relatively low cost. We’ve always said, for years, we always have these surge protectors that take care of our TVs and computers and those kind of things. Well, your HVAC system is the most important and most expensive part of your house. So for a relatively low price, a contractor can install that very quickly. I’ve done it myself and now protect that in the event of a surge in your house. And so our ability to continue to innovate with the seller of that business, who’s doing a great job working with our team and continue to explore more opportunities within the electrical end market and we’ll start talking about that more and more, now people see us as a provider of electrical products as well. And lastly, like I said, going through the same distribution channels is always a hallmark of our strategy and acquisitions that allows us to distribute that product to more folks than was previously probably done. In terms of financials, the initial press release we did on that kind of gave you some basic details and there’s earnout opportunities as that business continues to grow. The business is performing very well already. Margins roughly in line with where our overall margins are. So very pleased with the performance of that business and growth prospects that we’re already seeing in the first few months.

Q: I was hoping -- I know Jon asked about the PSP. I just want to dig into that a little bit more briefly. Just wondering, is that business fully integrated into the CSW network now? And kind of how do the acquisitions typically ramp up? Is there kind of a slower start or they kind of start at different speed? Just kind of help me out with that.

A: Yes. Sure, Tom. This is James. The first thing I'll say in terms of integration is getting it through our sales channel. And given the fact that we were already selling this product, that was very smooth. So this was not new. Some acquisitions we do, the day we bought the company is the first time we've ever sold the product, so it takes a while to get through the system. Dust Free, we did back in February and then PSP in August, were the model where we already knew the product. So we were already buying product from PSP and selling it through our channels. So that was very, very smooth. So in terms of commercial integration, very smooth. Now like I said in response to Jon's question, our ability to continue to blow that out through more of our distribution channels, introduce it to more folks, educate folks on the utility of that product will continue as we go along. In terms of systems integration, that's in process. Some of these acquisitions get done in a matter of a few months, some take a couple of years, depending on the need to do that. PSP is in the process of doing that, but not holding us back in any way from an accounting or financial standpoint. Our team has really developed the muscle now within Contractor Solutions, specifically with the numerous acquisitions we've done in the last 5 or 6 years to make this a very repeatable process. So yes, eventually, all these get on our ERP system, which makes it even smoother and cleaner, but our team has done a great job getting these products on the shelves, getting them in our portfolio. And then from a back-office financial and integration standpoint, that comes in due time. But no hiccups there. Nothing is holding us back in that respect.

Q: I think last time we spoke, I think it was on Q1, you indicated that in the back half of FY '25, there could be higher COGS, if you will, coming in from higher shipping rates for products that you're bringing into the country. I was just wondering, is that still the case?

A: It is, Tom. Yes, we've talked obviously over the years about ocean freight. Ocean freight has been higher than it was a year ago and even than it was 7, 8 months ago. And those costs on the crossing the ocean rates are pretty much baked in the system now, and that will be our second half COGS. So we have a pretty good sense now through March what that's going to look like. They started to come down. So as we enter the next fiscal year, we may have an opportunity for that to come back a little bit. But yes, it's a headwind for us. So you do have things a little higher than we would have originally thought back in budget season, back in the March, April time frame, at the beginning of our fiscal year. We know what those costs are. As Joe said, if those costs remain elevated, we have the opportunity to raise prices and push those through because they're -- that makes sense and they're justified. And the pricing power that we've always talked about is real, and that's something that we've alluded to in the past. I will say that there have been some other costs that have offset some of that, that have come down a bit, that's natural and all. But yes, we will exercise pricing action as we need to. But yes, we still see that second half COGS for the ocean freight higher than it was in the first half.

Q: I was just wondering specifically on the Contractor Solutions business, just wondering if there's been any change in the sentiment or their outlook given with similar maybe call it a mixed economic outlook?

A: Tom, I would not say as it relates to our products. I know that there have been inventory issues for the OEMs over some of the impending changes. The fact that we’re agnostic to OEM, we’re agnostic to refrigerants, we’re agnostic to SEER rating, all of those things really benefit us in those times. So I think the answer is no. I think that we’ve seen unit contraction over the last 2 years-or-so and some inventory issues. Deals like most of those are in the rearview mirror now. So no, we see the prospects is bright and do not have any overriding concerns at this point from the overall HVAC/R market.