CSW Industrials, Inc. (NASDAQ:CSWI) Q4 2023 Earnings Call Transcript May 25, 2023

CSW Industrials, Inc. misses on earnings expectations. Reported EPS is $1.17 EPS, expectations were $1.44.

Operator: Greetings, and welcome to CSW Industrials Fourth Quarter and Full-Year Fiscal 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. . As a reminder, this conference is being recorded. At this time, I’d like to turn the conference over to your host, Alexa Huerta. Thank you. You may begin.

Alexa Huerta: Thank you, Rob. Good morning, everyone, and welcome to the CSW Industrials fiscal 2023 fourth quarter earnings call. Joining me today is 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-K prior to the markets 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.

Joseph Armes: Thank you, Alexa. Good morning. And thank you for joining our fiscal fourth quarter conference call. I’m pleased to report that, in fiscal 2023, we continued our successful track record of delivering exceptional performance. Our commitment to treat our employees well, to serve our customers well and to manage our supply chains effectively drove exactly the kind of growth in revenues and profitability that we had hoped for. Fiscal 2023 represented another record year of revenue, EBITDA and earnings per share. Today, we reported record revenue of $758 million, 21% growth over the prior year. Organic growth represented 15.3% of the total growth, with the balance coming from our recent acquisitions, all of which are reported on our Contractor Solutions segment.

EBITDA reached a record $174 million or 31% growth over the prior fiscal year. Finally, our record EPS was $6.20, an increase of 41% compared to $4.39 as adjusted in the prior fiscal year. These record results are attributable to our diversified business model, disciplined capital allocation and commitment to operational excellence, which drove impressive operating leverage despite global and financial market uncertainties. As compared to the prior year, sales increased in all three segments, driven by positive pricing actions and growth from our acquisitions. Our Contractor Solutions segment achieved record sales of $514 million, including record HVAC/R end market sales of $418 million, an $83 million or 25% increase in our HVAC/R sales, including organic growth of $51 million despite a slight decline in unit volume.

Our Contractor Solutions team deserves recognition for exceeding our expectations again this year, while successfully integrating multiple acquisitions and managing significant challenges presented by inflation and supply chain constraints. I want to congratulate and thank Don Sullivan and his team, including Jeff Underwood, the segment’s senior vice president for sales and marketing for their extraordinary performance in fiscal 2023. In recognition of this team’s hard work, I’m pleased to share that we were recently named Supplier of the Year by Johnstone Supply, which is their only external vendor award that is given each year. Our Engineered Building Solutions segment grew by $7 million or 7%. Scott Stratton and his team effectively promoted existing and newly developed products and maintained market share gains due to competitive lead times, successfully overcoming the commercial construction end market decline during our fiscal 2021 and 2022.

As a result of the EBS team’s productive commercial efforts, this segment’s backlog, as of the end of 2023, achieved an all-time high, and then reached another all-time high by the end of April, signaling a tailwind into fiscal 2024. Our Specialized Reliability Solutions segment achieved record revenue of $147 million, which represents $31 million of organic revenue growth or 27% as demand strengthened in all end markets served and commercial and operational execution improved significantly. In fact, segment revenue in the current fiscal year exceeded fiscal 2021 by an impressive 88% or $69 million. Since Mark Bass joined CSWI in June of 2021, he and his team have enhanced our competitive position within the marketplace, and has strategically addressed the demand for our market-leading, highly specialized products.

On the heels of this solid execution in fiscal 2023, we remain confident in our ability to achieve further growth and strong margins in fiscal 2024. During the last fiscal year, we executed on all aspects of our capital allocation strategy, investing $58 million in acquisitions, including Falcon, Cover Guard and AC Guard, as well as $14 million in capital expenditures. We returned an aggregate of $46 million of cash to our shareholders through our share repurchase program and dividends. Subsequent to fiscal year-end, the board approved a 12% increase in our quarterly dividend to $0.19 per share, signaling our confidence in the business and in our ability to generate cash. On the M&A front, I’m pleased to report that all of our acquisitions during fiscal 2023 are progressing well.

I’m impressed with the efficient integration of all of our acquisitions, and our ability to offer these new products to our broad base of distribution customers, adding vitality to our portfolio of products. Our M&A strategy remains active with many of the best ideas and opportunities generated organically from within our organization. Our capital allocation decisions remain focused on maximizing shareholder value on a risk adjusted returns basis. This disciplined approach favors our current platforms, serving the same customers and end markets through our extensive distribution channels. Inorganic growth remains a key strategic initiative, and we continue to maintain an active pipeline of acquisition opportunities. The strength of our balance sheet and access to capital provides ample capacity to act decisively and quickly on acquisitions as opportunities arise.

Each quarter, we provide an update on our commitment to treat our employees well. This quarter, I would like to focus on our pay for performance culture. For fiscal year 2023, our Board of Directors has once again approved annual performance bonus and profit sharing incentive payments. As we have reported previously, all domestic employees are eligible participants in our employee stock ownership plan, or ESOP, which results in direct alignment of interests with our shareholders. Our profit sharing programs in fiscal 2023 included an 8% ESOP contribution, plus a 3% discretionary 401(k) contribution, which is in addition to our standard 401(k) participant match of 6%. Of note, our 401(k) plan also boasts a 96% participation rate, which is significantly higher than the recognized industry benchmark.

Providing for a safe, secure and dignified retirement, along with aligning interests with our employees through our competitive profit sharing programs, are some of the ways we strive to be an employer of choice, attracting and retaining quality talent. In fact, as a result of maintaining a consistent focus on our employee centric culture, we continue to exceed industry standards in retention rates. Recently, approximately 79% of our employees participated in our fiscal 2023 engagement survey conducted through Great Place to Work, which showed that our engagement scores remained high, and we were pleased to announce, in January of this year, that we received the Great Place to Work certification. Our products remain in high demand. And our team is working diligently to treat our employees well, serve our customers well, and manage our supply chains effectively.

And I truly believe that our collective efforts have positioned the company for long-term sustainable growth and profitability. At this time, I’ll turn the call over to James for a closer look at our results.

James Perry: Thank you, Joe. And good morning, everyone. Our consolidated revenue during fiscal fourth quarter 2023 was $196 million, a 13% increase compared to the prior-year period. Consolidated gross profit in the fiscal fourth quarter was $85 million, representing 18% growth, with the incremental profit resulting predominantly from pricing initiatives and the multiple acquisitions that we made during the year. Gross profit margin was 44% as compared to 42% in the prior year period. The gross profit margin increase resulted predominantly from positive pricing actions across our three segments. The operating expense margin, defined as operating expense as a percentage of revenue, was 23%, an improvement of 180 basis points compared to the prior year period.

Fiscal fourth quarter EBITDA increased 33% to $49 million as compared to the prior year period. Our EBITDA margin was 25% as compared to 21% in the prior year fourth quarter, with the improvement due primarily to the higher gross profit margin and discipline around operating expenses. Reported net income attributable to CSWI in the fiscal 2023 fourth quarter increased $27 million or $1.74 per diluted share compared to $18 million or $1.17 in the prior year period. Now, I will transition to a discussion of our segments. Our Contractor Solutions segment, with $134 million of revenue, accounted for 68% of our consolidated total and delivered $14 million or 11% of growth as compared to the prior-year quarter, comprised of organic revenue growth of $9 million and inorganic growth of $4 million from our recent acquisitions.

Quarterly segment EBITDA was $43 million, a 32% margin, compared to $35 million, a 29% margin, in the prior year period. This margin growth is a testament to the disciplined pricing actions and strong operating management in this segment. Our Engineered Building Solutions segment revenue grew to $25 million, a 5% increase compared to $24 million in the prior year period. EBITDA was $3.1 million, or 12% of fiscal 2023 fourth quarter revenue, a 43% increase from $2.2 million or 9% of fiscal 2022 fourth quarter revenue as a favorable project mix was further supported by a reduction in operating expenses. Bidding and booking trends continue to demonstrate strength as our year-to-date bookings and backlog increased by approximately 24% and 36%, respectively, as compared to the prior year period.

As at the end of the fiscal 2023 fourth quarter, our book-to-bill ratio for the trailing four quarters in this segment improved to 1.2 to 1, leading to a record backup. Our Specialized Reliability Solutions segment posted organic revenue growth of $8 million or 25% due to incremental sales volumes from both our legacy Whitmore business and the Shell-Whitmore joint venture along with pricing actions that continue to provide tailwinds. Segment EBITDA and EBITDA margin improved significantly to $8.2 million and 21% in the fiscal 2023 fourth quarter compared to $5.3 million and 17% in the prior year period. This represented impressive EBITDA growth of 55%. Turning now to our fiscal full year results. We achieved a record consolidated revenue of $758 million, representing 21% growth as compared to fiscal 2022, with all segments reporting organic growth.

Consolidated gross profit in the current year was $318 million, representing 24% growth, with the incremental profit resulting predominantly from pricing initiatives and the multiple acquisitions that we made during the year. Gross profit margin of 42% was on par with the adjusted gross profit from the prior year. Despite the inflation in acquisitions, the operating expense margin of 24% showed an improvement of 170 basis points compared to the prior-year period, demonstrating the discipline and effectiveness in our management of operating expenses. In the current year, we reported a 31% increase in EBITDA to a record $174 million, equating to a margin of 23% as compared to an adjusted $133 million and 21% in the prior year. These results translated into record EPS of $6.20, an increase of 41% compared to an adjusted $4.39 in the prior year.

Our Contractor Solutions segment, with $514 million of revenue, accounted for 68% of our consolidated total and delivered $97 million or 23% growth. This was comprised of organic growth of $61 million and inorganic growth of $36 million from our acquisitions. Segment EBITDA increased 24% to $153 million, a 30% margin, compared to $124 million and a margin of 30% in the prior year. Continuing to our Engineered Building Solutions segment, which accounted for approximately 14% of our consolidated total, with $104 million of revenue in the current fiscal year. This reflected a 7% increase over the prior year. Segment EBITDA was $14 million, a margin of 14%, an improvement from segment EBITDA of $13 million and a margin of 13% in the prior year period.

Our Specialized Reliability Solutions segment posted impressive organic revenue growth of 27% or $31 million due to incremental sales volumes, driven by strengthening end market dynamics, price initiatives and increased volumes to the Shell-Whitmore joint venture. Segment EBITDA and EBITDA margin improved to $26 million and 18% compared to $15 million and 13% in the prior year. On our fiscal 2023 first quarter call, we affirmed our commitment to strong free cash flow generation, prudent working capital management, and maintaining sufficient liquidity to support our strategic objectives. We ended the fiscal 2023 year with $18 million of cash and reported cash flows from operations of $121 million, a 76% increase over the prior year. This was due to increased profit and improved management of working capital as compared to the prior year.

For the year, our free cash flow, defined as cash flow from operations less capital expenditures, was $108 million or $6.91 per share as compared to $53 million and $3.38 per share in fiscal 2022. Our free cash flow conversion rate, defined as free cash flows as a percentage of net income, was 111% in fiscal 2023, an improvement from the conversion rate of 79% in the prior year. At fiscal year-end, we had $253 million of borrowings outstanding under our $500 million revolving credit facility, which resulted in a borrowing capacity of $247 million. This resulted in a leverage ratio in accordance with our credit facility of approximately 1.3 times debt to EBITDA, well within our stated range of 1 to 3 times. This provides us with ample liquidity and flexibility to execute on our organic and inorganic strategic initiatives.

In early February of this calendar year, we entered into an interest rate swap, which fixes the SOFR portion of the first $100 million of our revolver borrowings at 3.85% through May of 2026. This compares favorably to the current comparable base rate of over 5.2% and settles monthly. This swap extends to the current expiration of our revolver in May of 2026. This fiscal year, we invested $58 million of acquisition capital. We returned $36 million to shareholders the share repurchase, reducing our share count by approximately 336,000 shares. We did not repurchase any shares under our program during the fiscal fourth quarter. We have $100 million outstanding on our current share repurchase program at the end of the year. As part of our broad capital allocation strategy, we remain committed to opportunistic market repurchases, guided by our intrinsic value based model.

We have 15.5 million shares outstanding, approximately the same total as when we went public over seven years ago. This is impressive, given that we have approximately tripled our EBITDA since that time, and have used our shares in acquisitions and in our equity compensation programs, but have repurchased a similar number of shares to what we have used. The company’s effective tax rate for fiscal 2023 was 23.3% on a GAAP basis, which aligned with the company’s previous expectation of 23% to 24% as discussed during our fiscal 2023 third quarter call. We currently expect a tax rate of approximately 25% for fiscal 2024. As we look to fiscal 2024, we expect to have revenue growth across all three segments and at the consolidated level, which, when coupled with meaningful operating leverage, will result in solid year-over-year EBITDA and EPS growth.

As we look at our cadence of earnings over the four quarters, we expect our normal seasonality with the fiscal third quarter ending in December being the lowest level of earnings. With higher interest rates than last year, we expect our interest expense in the first two quarters will be higher than the prior year periods, and the year-over-year comparison for that line item for the back half of the fiscal year will depend on our outstanding level of debt. Our operating teams have done a great job maintaining the pricing that we achieved during the rapid inflation of the last several quarters. As we have seen reductions in the cost of certain inputs, including ocean freight, this leads to higher margin potential. We will continue to keep a close eye on our costs and are confident in our ability to achieve the profitability and margins that we and our shareholders have come to expect.

As we look at our three operating segments, we expect revenue and profit growth in our Contractor Solutions segment to continue outpacing the categories we serve, driven by the pricing actions we have taken and maintaining, as well as adding new customers and selling more of our products to existing customers. While expectations, as reported by the public HVAC/R OEM companies, are for unit volumes to decline this year, our team is committed to deliver top and bottom line growth through strong commercial and operational execution. With the Engineered Building Solutions backlog at all-time highs, our team is focused on execution and expect to outperform the construction end market, while growing revenue and improving margins. Our Specialized Reliability Solutions segment expects to deliver another year of top line growth, although at a slower rate than the exceptional growth of the last two years, returning to our historical GDP plus growth norms, while expanding the strong improved margins we achieved in fiscal 2023.

Before I turn the call back to Joe, I’d like to offer an enthusiastic welcome to our new Vice President of Investor Relations and Treasurer, Alexa Huerta, who started with CSW just this week and opened our call today. Alexa brings a tremendous background of financial and IR experience to us. And I look forward to introducing her to our investment community in the coming days, weeks and months as we meet with you. With that, I’ll now turn the call back to Joe for closing remarks.

Joseph Armes : Thank you, James. As we conclude one fiscal year and begin another, I want to take a moment to mention a few metrics with a longer term perspective. Our revenue compound annual growth rate for fiscal years 2018 through 2023 was 18%. Our adjusted EBITDA CAGR was 22%, with an adjusted EBITDA margin during this period of 22% and our adjusted EPS CAGR was 24%. The revenue growth, of course, has included acquisitions, and we would expect to continue to grow inorganically through acquisitions, thereby supplementing our organic growth. All of this has resulted in a total shareholder return of 377% since we went public in the fall of 2015, creating tremendous value for all of our shareholders. As we look ahead, we believe that our attractive and diverse end market exposure, strong customer relationships, enviable distribution channels, best-in-class products, with hard earned reputation for quality and innovation, and a healthy balance sheet to execute on growth opportunities gives us every reason to be enthusiastic about fiscal 2024.

And as always, I would like to close by thanking all my colleagues here at CSWI, who collectively owned 3.5% 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.

Q&A Session

Operator: . Our first question comes from Jon Tanwanteng with CJS Securities.

Jon Tanwanteng: Joe or James, just wanted to get a little bit of clarification. I think the press release, you expected margin growth in each of the three segments going forward. Is that kind of a directional guidance for fiscal 2024 and is that off of the 22% EBITDA margins you did for the year in 2023?

Joseph Armes: This is Joe. We have a long history of not providing guidance unless there’s some correction that needs to be made or some misperception in the market. So this is very, very conceptual. But our commitment has always been to outpace the top line growth for the markets we serve, and then always grow profits faster than revenue. So that’s all the guide we’re willing to give at this point. James, you want to add anything?

James Perry: We wanted to be clear that we do expect to grow revenue across the segments in my remarks and grow the margin. We’ve seen some nice momentum from a couple years ago. As you well know, Jon, we’ve done a great job in our businesses keeping up with inflation through pricing, and we took a bit of a margin hit there for a year or so as we were kind of catching up to that, given the math, as we’ve talked about quite a bit. But we’ve kind of turned that corner now. We’ve started expanding margins again, and we expect that momentum to continue.

Jon Tanwanteng: Can you just talk about the macro assumptions underlying your outlook as we go forward? I know several economists and the other firms have called for a recession. There’s always a risk of default coming. But what are the thoughts on how broader demand could affect your business and if you’re planning for that at all?

James Perry: Jon, we always keep an eye on that, obviously. The best thing is not necessarily TV and newspapers, but talking to our customers and suppliers and understand on the ground and our commercial and operating teams do a tremendous job of that across the segments. We continue to see nice demand. Orders have been good the last few months across the board. You look at Contractor Solutions, we talked about kind of the public OEMs and those companies in that HVAC space are looking for unit volume slowdown this year. You’re coming off a couple years of pretty tough comps. You had tremendous couple of years of unit volume growth. So that’s expected. We expect to outperform that. They’ve generally talked about single to high – or mid to high single-digit declines.

And we expect outperform that on a unit volume perspective. And then, as I say, grow revenue through the pricing we have and other methods and certainly grow profit at a higher rate. So you’re seeing a little bit of headwind there. One thing you’re seeing is existing home sales have slowed down a bit because people don’t want to give up their good mortgage rates they have. We’ve seen that anecdotally lately, there’s some good numbers in new housing starts. But the good thing about our business is, we’re not as tied to the OEM market. So whether it’s a repair and maintenance or replacement or new HVAC unit, our products are going into that and we’re continuing to penetrate with the acquisitions we’ve made into having more of the water heater, more of the HVAC system and those type things in the home.

You look at Engineered Building Solutions, we’ve really worked hard, Scott and his commercial team. pinpointing those areas that do have opportunity. Institutional construction is important to us. Hospitals or airports or education are less dependent on equity returns and those type things, a little less dependent on interest rates. Multifamily, especially in Canada, continues to be a nice place for us with our Greco business up in Ontario. So we continue to focus on those bright spots and been able to grow backlog as a result. And we’ll continue to lean into those areas and be sure that we’re going after the right sectors. In Specialized Reliability Solutions, again, Mark and his commercial team and operating team have done a great job doing the exact same thing, leaning into those energy markets.

Our joint venture with Shell-Whitmore continues to gain momentum in the rail and mining sector in North America. The team has made some good international strides where they see opportunities across the globe. So I would tell you that while we always have an eye out on the macroeconomy, we’re much more micro focused, and our businesses have done a great job shifting our commercial efforts and our production efforts on those areas that have the most opportunity for growth.

Joseph Armes: Jon, this is Joe. The only thing I’d add to that, you raised the R word, recession. And that is, we can’t predict, but we are absolutely prepared. Diversified in end markets, diversified across our product portfolio, diversified businesses, we have a really strong balance sheet, just real strong cash generation. And we have a lot of consumable type products and non-discretionary. And so, those are the attributes that our business has that makes us more resistant to cycles. And so, certainly, just to add to what James said, I think our business is especially resilient, and so we’re prepared, almost regardless of what the economic cycles are.

Jon Tanwanteng: Do you have a snapshot of, one, the pricing versus input spread that you have in the fiscal first quarter compared to where you were in Q4? And kind of a supplement to that, do you still have high priced inventory coming through? And is that going to be a tailwind as you come off of that going forward?

James Perry: I think if you look at the margins in each segment, as you go through the cadence of last year’s earnings, you kind of see that that come into fruition with the margin improvement. To your point, you have a lag on inventory, especially that inventory that comes across the ocean. So, that can be a couple quarter lag. So I think as you went through the calendar year last year and then our fiscal year late in the year, some of that was still coming through. I think most of that’s through the system now. There’s always some that’s out there in the inventory. But generally speaking, we have a good level of inventory turns. So you would have a little bit of that. But ocean freight has been down for a while now. So that’s working its way through the system.

Our last round of significant price increases that were inflation related were last summer. So we saw a few more months before we start lapping the pricing. And then we had our usual seasonal and annual type price increases earlier this calendar year. But I think in terms of the high cost inventory, there may be a little in the system, but most of that’s worked its way through, thus the confidence we provided with that tailwind with margin improvement that you asked about at the beginning.

Operator: Our next question is from Alex Hatman with Sidoti & Company.

Unidentified Participant: This is Alex on for Julio Romero. Congrats on the results. My first of two questions is about operating leverage and the joint venture. Can you talk to the operating leverage that you’ve seen come to fruition so far and what your expectations are going forward?

James Perry: This is James. As we’ve talked about, we continue to pick up volume through the Shell-Whitmore joint venture. It’s been a nice partnership. And as we said, it would take a while to get the formulations and get the strategy together. And we’re a couple years into that. And I think we’re seeing some nice momentum. We’re seeing some profitability over the last few quarters are just coming through. And we’ve always said that that facility has room to grow. And the Shell joint venture has certainly helped us with the absorption and that contributes to the overall margins of the joint venture. And Whitmore, we can add equipment there and add volumes to that base, then you continue to see the joint venture have good profitability opportunity through absorption of the volume.

Unidentified Participant: My second question is regarding the Contractor Solutions segment. Can you talk about how much of a driver maintaining price versus benefiting from lower costs were for this quarter and then if you can see that continuing?

James Perry: It’s hard to quantify exactly and break it up. But maintaining price have been very important to us. And we had our kind of annual price increase during the fiscal quarter that that’s just normal as that goes through in the late winter, early spring. So, yeah, our team has done a tremendous job of maintaining pricing where it needs to be. And we’ve talked about where we sit in the value chain and in our ability to do that and maintain our customer base and really strengthen that. So pricing maintenance has been important. Yeah, we’ve seen some input costs come down. The biggest we’ve talked about a lot the last couple of years, obviously, is the container rates, which are now down back to where we were a couple of years ago.

And we rely a lot on ocean freight from our own facilities and third parties. I think it really has – you’ve hit on it well, Alex. It’s been a good combination between maintaining that price and seeing costs coming down that led to margin expansion. Hard to break those out necessarily because there’s so many moving parts. And each product and each kind of product category has its own dynamics. But overall, the team has really done a nice job with those two, which obviously then adds to a really nice gross profit, and with operating expense leverage, adds to an even better EBITDA margin.

Unidentified Participant: My last of three questions is on the financials. And I think you touched on this a little bit, inventory, but would love to hear more about some of the efforts to reduce working capital and how much more runway you think you have for improvement there.

James Perry: This is James again. I’ll tell you, I’m really proud and pleased with the team. There’s been a concerted effort in all three components of that. With accounts receivable, the team has done a really nice job, getting their teams together and focused on collections and being sure that we work with our customers to have them pay the invoices timely. And a lot of that is on our end, being sure that we get those bills out timely and accurately and working with our customers and the relationships we have. So the team has done a nice job shaving some days off of that. You only get a point in time at the end of the quarter, when you look at a balance sheet and go through the months and the quarters, we’re seeing some really nice momentum there and shaving some working capital dollars off by improving accounts receivable efforts across the segments.

Accounts payable too, we want to treat our vendors fairly and pay the bills when we’re supposed to, but where we see opportunity to extend some terms, then we’ve been able to leverage that a little bit. Obviously, inventories, that’s the big piece. And we continue to hold strategic inventory in certain products that we rely on overseas production, both our own and third party. Because as we’ve often said, things can happen with delays and those kind of things. And we’ve seen what that looks like over the last couple of years. So holding a little more than we did before is appropriate. And obviously, you go back a few years before we acquired TRUaire. We didn’t have an internal operation overseas that we have now in Vietnam, which is a lot of our production in the Contractor Solutions space.

We’re going to have more inventory. So, you’re not going to get all the way back to where we were pre-acquisition. But we continue to look strategically at where to produce our products, where to where to procure our products. And as we said on the last call, while our days continue to improve, there may be a little bit of improvement left, but I’m really pleased and proud of how the teams have done managing working capital, so we have those dollars and cash flow to put to work and good returns, organically and inorganically, but at the same time making sure, as Joe has often said, that we’ve got the product with the type of margins that we achieve for our shareholders in stock to sell. We don’t want to be out of stock of something and miss a sale.

Operator: Our next question is from Jon Tanwanteng with CJS Securities.

Jon Tanwanteng: Just a question on the Whitmore facility and the joint venture with Shell. Where are you in filing that to capacity? And what is the margin limit for this segment if utilization continues to go up there?

James Perry: This is James. We talked about – we’re kind of in what we call phase three of the capital expenditures. You’ll see that flow through the year over the next few quarters. And then we’ll have the equipment fully ramped up and get that in production over the course of the fiscal year. We’ll provide updates as we go along because it’ll be a bit of an increase to our normal CapEx. But, obviously, we pay half and Shell pays half. So we’ll point to that on the statement of cash flows as appropriate. So we’re still on that journey. The first couple of phases are through the CapEx. And we’re, as I said, increasing volumes month to month and quarter to quarter. And that phase three will allow us over the next fiscal year and even into fiscal 2025, continue to ramp that up to where we expected to model this when we started that literally just over 25 months ago now.

In terms of margin potential for the segment, which is inclusive of that, we’ve guided to reaching 20%. As you recall very well, Jon, as a veteran with this, we were down in the single digits in the depths of the pandemic. We got over the 20% mark this fiscal fourth quarter. And for the year, we were in the high teens. So we think seeing that margin now at or above 20% in the current fiscal year is certainly achievable and may bounce around quarter to quarter, and the joint venture is an important part of that.

Jon Tanwanteng: Could you talk a little bit more about the seasonal restocking at your HVAC and plumbing distributors? What are they buying this year compared to last year? If there’s any – compare the strength and weakness, whether it’s mini splits or things from recent acquisitions. And I don’t know if you have this kind of data, but if there’s more MRO or OEM products that are being pushed through, just to help us understand the size and shape of what you’re seeing this year.

James Perry: It’s a great question. When you talk about inventory stocking, clearly, you’ve heard the OEMs and the distributors, more importantly to us, talk about the level of inventories they have, and your revenue and inventory levels are a little different than they were a couple years ago, of course, but I think they’ve reached generally a nice equilibrium, it sounds like. There may still be a little destocking of certain products. But we continue to see nice order volume. Just as we manage our inventory, they do as well. And they don’t want to miss a sale either. They’ve got attractive margins like we do. So it’s a really nice partnership and dynamic that we have in working together. And again, Jeff Underwood and his commercial team, as Joe pointed out specifically, really worked closely with our customers on a daily basis to be sure they’ve got what they need.

And our ability now with the seven distribution centers with RectorSeal and TRUaire combined, and then Shoemaker, with their facility in Washington, we can really supply our customers what they need very quickly and very pinpointed. In terms of the areas, I won’t get overly detailed. But you mentioned mini splits, I’ll say you recall that last year, there were some shortage on the mini split OEM side. They had some production delays. So that led to a little less mini split product demand last year. They seem like they’ve caught up what we’ve seen and heard. And so, that leads to a little more for us. And that’s a product area that we excel in. It’s a product area where we have a lot of things that go into the installation of a mini split. And those products carry nice aggregate margins for us as we make those sales.

So I’d highlight that area maybe, but I wouldn’t say I’d point to anything – I wouldn’t distinguish between MRO versus pure replacement or new. As you know, a lot of that’s pretty fungible. Our products go into to all applications. So I don’t think I’d point to just repair or just replacement or just new necessarily. As we often say, we don’t know exactly where it goes. But I will tell you, hopefully, that’s not too overly vague that we are seeing nice demand, we’re seeing things as we expect. And that leads us to the confidence we’ve provided in revenue and margin growth in that segment.

Joseph Armes: The other thing I would add, Jon, is part of your question really goes to mix and we are highly focused on selling more of our higher margin products. Last couple of years, just keeping up with demand, obviously, was job number one, but in a slower growth environment, I think it’s really important to focus on the higher margin products. If we can grow those faster than overall growth rate, mini splits has been a great example of that. Those are really great products for us and that growth being faster than the category growth, that’s been a key to our success, and broadening that concept throughout the company and making sure that we are here highly focused on selling more of our higher margin products. That mix will show up in our results over the course of time.

Jon Tanwanteng: The last one, because I always have to ask, just update us on the relative attractiveness of places to deploy capital. You Do you see any really good M&A opportunities right now? Or does it make more sense to be doing other things to get cash?

James Perry: We appreciate your asking that. It’s an important focus for us as well. Our allocation of capital philosophy has not changed. And that means we’re going to do everything on a risk adjusted returns basis. We think about our cost of capital, which has obviously gone up. Interest rate is up. Now we’re mitigating some of that through our swap, but cost of capital has gone up. And so, hurdle rates have gone up. Having said that, as you’ve seen in the past, our ability to buy really attractive, accretive businesses at reasonable valuations, I think, continues. We continue to see a nice active pipeline. And that continues to be a focus for us. The hurdle rate has been raised. There’s no question about that. Paying down debt on a relative basis is more attractive than it was a year or two ago. But acquisition growth is an important part of our strategy, and continuing to leverage our distribution channels is going to be an important part of our success.

Operator: Our next question is from Alex Hatman with Sidoti & Company.

Unidentified Participant: I wanted to follow up on something you mentioned earlier. You spoke to the demand for residential HVAC. And I wanted to hear a little bit more about what you’re seeing around non-residential. Are you seeing any sort of trends today compared to three months ago? And how you see that playing out?

Joseph Armes: Alex, that’s a really, really small part of our business, first and foremost. And so, I don’t know that I would comment on those trends at this point. Really, the residential piece is by far the largest piece of our business, handful of products that can be used in either residential or commercial, and then only a very few products that really address the commercial market. So having said that, we haven’t seen anything that’s out of the ordinary for us. As James said, our order pattern seems normal and consistent with what we would expect. So nothing really to note there for you.

Operator: We have reached the end of the question-and-answer session. I would now like to turn the call back to management for closing comments.

Joseph Armes: Great. Thank you very much. We really appreciate everyone joining us for this conference call. And we will continue to be good stewards of your capital and look forward to speaking to you at the end of our Q1.

Operator: This concludes today’s conference. You may disconnect your lines at this time and we thank you for your participation.