Huttig Building Products, Inc.
Q2 2019 Earnings Call Transcript

Published: 30 Jul 2019

[Operator:]

Good morning. And welcome to the Huttig Building Products' Second Quarter 2019 Earnings Call. Participants will be in a listen only mode until the end of the call when the Company will have a question-and-answer session. Please limit your questions to one question and one follow up question.I would now like to turn the call over to Philip Keipp, Vice President and Chief Financial Officer. Please go ahead, sir.

[Philip Keipp:]

Thank you. And welcome to Huttig's second quarter 2019 earnings call. With me this morning is Jon Vrabely, President and Chief Executive Officer and Bob Furio, Executive Vice President and Chief Operating Officer. During the call today, we will discuss our second quarter financial results and provide commentary on other aspects of our business. Following our prepared remarks, the operator will open up the line for questions.Let me take a moment to remind you that today's discussion reflects management's views as of today, and may include forward-looking statements. Actual results could differ materially from those currently anticipated, and Huttig disclaims any obligation to update information discussed on this call as a result of developments that occur afterward. Also, to the extent you are listening to this call on replay, information could have already changed. Additional information about factors that could potentially impact the financial results is included in the earnings release issued yesterday and in our filings with the SEC.During this call, certain non-GAAP financial measures will be discussed. A description of any non-GAAP adjustments and reconciliation to the most comparable GAAP measures can be found in the earnings release issued yesterday, and on the Company's Web site at www.huttig.com. Today's call is being webcast live and is being recorded. If you ask a question, it will be included in our live transmission, and in any future use of the recording. You can replay the call on the Investor Relations page of the Web site under Financials.Now, it is my pleasure to turn the call over to Bob.

[Bob Furio:]

Thank you, Phil. Good morning. And thank you for joining our second quarter 2019 earnings call. I will provide an update on our strategic growth initiatives. And Phil will discuss our financial performance in the second quarter and for the first half of the year.As we continue to drive change throughout our business with our strategic growth initiatives, we have faced the number of headwinds in 2019. There has been a softening on the residential construction market, prolonged inclement weather across many parts of the country and some temporary disruption caused by our major ERP system upgrade, which was completed in the second quarter.From a market perspective, single family starts declined 6.2% during the quarter and 4.9% on a year-to-date basis, while the more volatile multifamily segment grew 16% during the quarter and declined 29% on a year-to-date basis. We estimated based on our composite sales that our market was flat during the quarter, and down 1.5% on a year-to-date basis. In comparison, our sales declined 2.2% during the quarter and 1.3% on a year-to-date basis. It is impossible to quantify the impact of the inclement weather in the markets we serve. However, we believe it has negatively affected construction schedules in many parts of the country.In May 2019, we completed a major ERP system upgrade, which has significantly enhanced our information technology platform. This is the combination of our project, which has been several years in making, representing the significant investment by our company. As with many major ERP projects of this magnitude, some temporary disruption did occur. We believe this had an impact on our second quarter sales, particularly in the millwork category, though, impossible to quantify. Based on our in-depth measurement of underlying performance metrics, significant progress has been made toward remediation. We believe all issues will be fully remediated in the next 60 to 90 days.On our last call, I stated we address three focus areas. One, executing our sales plan to grow share above the residential construction market. While we’re generally flat with the market, we will continue to focus on this area as some of the headwinds dissipate. Two, improve our gross profit and operating leverage. Our year-to-date gross margins are down 30 basis points, in large part through the sales mix. However, our gross margins were up 10 basis points to 20.3% in the second quarter.We need to better lever our expense structure, which was negatively impacted by moderately lower sales volume. And finally, managing our working capital will reduce debt and improve liquidity. Based on the seasonality of our business, we tend to use cash and build debt, during our second and third quarters our peak sales and working capital periods. Because of our emphasis on working capital management, our debt levels are down $19.2 million compared to a year ago. Phil will speak to this further in his prepared remarks.Turning toward our strategic growth initiatives. Sales of Huttig-Grip products generally followed our overall performance, down 2% in quarter. On a year-to-date basis, our Huttig-Grip sales were up nearly 5%. Pre-finished store sales were down 3.1% for the second quarter and up 4.6% year-to-date. We believe second quarter sales performance reflect softening marketing conditions, as well as some of the disruption we experienced with our system upgrade.We have made significant investments in our growth initiatives, and continue to gain traction with new customers and new customer segments. The overall market challenges referenced earlier have dampened our growth trajectory. However, we remain optimistic about these initiatives that are present. From a working capital perspective, we have made progress in reducing our fastener inventory levels. They are down approximately 18% from peak levels.We remain focused on further reducing these inventories through normal sales attrition and inventory management. Results from our initiatives have taken room and are showing progress. Specifically in our second quarter, sales of Huttig-Grip fasteners to our core customers from our warehouse were up 12.5% as we continue to pick up shelf space. Sales of packaged fasteners for lumber dealers were up nearly 60%, and margins on total fastener --- and total sales of packaged fasteners grew 400 basis points over the prior year Q2. These trends are in line with our overall fastener market strategy based on our long-term projected sales mix in this category.Now, I'd like to turn the call over to Phil to discuss our financial performance.

[Philip Keipp:]

Thank you, Bob. Second quarter 2019 net sales were $218.5 million, which is $4.9 million or 2.2% lower than the second quarter of 2018. Through the first six months of 2019, net sales were $415.9 million, which is $5.5 million or 1.3% lower than 2018. As Bob mentioned, our sales performance is indicative of the headwinds we have faced in 2019.Gross margins were 20.3% of net sales during the second quarter of 2019 compared to 20.2% a year ago. Through the first six months of 2019, gross margins were 19.6% of net sales compared to 19.9% a year ago. The 30 basis point reduction in gross margin was primarily attributable to a higher proportional increase in building products sales as compared to other higher margin product categories, as well as pressure from the competitive pricing environment and higher costs from customer program promotions.Operating expenses were $41 million during the second quarter of 2019 compared to $43 million a year ago. Personnel costs decreased $0.3 million as savings from cost management initiatives were offset by higher medical costs. Non-personnel costs decreased approximately $1.7 million, primarily due to non-recurring litigation and settlement costs of approximately $2.5 million in 2018. Second quarter 2019 non-personnel expenses also reflect higher rent on our operating facilities and equipment, including expansion efforts.As a percentage of sales, operating expenses decreased to 18.8% in the second quarter of 2019 compared to 19.2% in the second quarter of 2018. Adjusted for non-recurring litigation settlement costs operating expenses were 18.1% in 2018. Year-to-date, operating expenses were $80.6 million compared $82.2 million in 2018. Personnel costs decreased $0.5 million as lower wages and variable compensation costs were partially offset by higher medical costs. Non-personnel costs decreased $1.1 million, primarily due to non-recurring litigation and settlement costs of approximately $3.3 million in 2018. Year-to-date, non-personnel expenses also reflect higher rent from our operating facilities and equipment, including expansion efforts. As a percent of sales, operating expenses were 19.4% in 2019 compared to 19.5% in 2018 year-to-date. Adjusted for non-recurring litigation settlement cost, our operating expenses were 18.6% in 2018.Operating income was $3.3 million the second quarter of 2019 as compared to $2.1 million a year ago. For the first six months ended June 30th, operating profit was $1.1 million and $1.6 million in 2019 and 2018, respectively. We recorded an $11.8 million non-cash tax charge in the second quarter of 2019 related to an increase in net deferred tax asset valuation allowance. The increase was required based on applying the criterion under U.S. GAAP. Most of our net deferred tax asset is comprised of federal tax loss carry forwards, which will not begin to expire until 2030. The deferred tax valuation loss will be assessed each reporting period, and the amount of our net differed tax assets considered realizable could be adjusted in future periods based on our financial performance.The net operating loss carry forwards remain available to offset future taxable income. As a result of the foregoing, we reported a net loss of $10.3 million during the second quarter of 2019 as compared to net income of 200,000 in the second quarter of 2018. Year-to-date, we incurred a net loss of $13.5 million as compared to a net loss of $300,000 in 2018. Adjusted EBITDA was $5.2 million in the second quarter of 2019 as compared to $6.5 million in the second quarter of 2018. Adjusted EBITDA was $4.9 million through the first six months of 2019 as compared to $8.7 million in 2018.With regard to our balance sheet, we ended the second quarter of 2019 with total debt of $160.3 million compared to $179.5 million a year-ago. We used approximately $14.3 million in cash from operating activities in the second quarter 2019 compared to $30.1 million in the prior year period. For the six month period, our cash usage from operating activities declined by $50.2 million as compared to 2018 from $70.2 million to $20 million. The lower level of cash utilization for the current year is primarily due to improved working capital management. During the quarter, we borrowed $19.9 million on our revolving credit facility to finance operating cash needs, bringing the outstanding balance to $154.6 million as compared to $175.6 million a year ago, a $21 million reduction in our senior credits debt. We remain sharply focused on recognizing debt reduction opportunities through improve working capital management.Now, I'll return the call over to Jon for closing comments.

[Jon Vrabely:]

Thank you, Phil. During the second quarter and for the first half of 2019, we continued to make meaningful improvements in some aspects of the business and continued to face challenges in others. We measure our sales performance through the market based on our estimated revenue by market segments against the actual growth or decline in the respective segments. Since we do not have downstream visibility to know with certainty which segments the products are ultimately used, it is not an exact science. Over the course of a six to 18 month period of time, this methodology is generally directionally correct. But the analysis can be skewed over shorter periods of time due to severe volatility between segments as we experienced in the first half of 2019.On a year-to-date basis through June 30th, total housing starts are estimated to be flat versus prior year. The single family -- while single family starts have been volatile on a month-to-month basis, with the exception of January 2019, the trend has been fairly consistent, averaging approximately 6% to 7% below prior year. Multifamily starts have been extremely inconsistent throughout the year with Q1 starts being down an estimated 18% and Q2 starts being up approximately 16%.While the repair remodel market tends to follow the general direction of the new construction market, it also tends to be much less volatile in the short-term and over the long term, which is why we have been focused on continuing to diversify our revenue stream. That said, everyone in the industry faced the same market volatility and weather-related sales challenges that we did in the quarter with two exceptions. We experienced a negative impact on direct and warehouse fastener sales to our targeted growth customer segments as they bought ahead of the additional 15% Chinese steel tariffs implemented in the quarter. And the disruption we experienced to sales as a result of our ERP upgrade.On a positive note, as Bob and Phil stated, we continue to make progress in improving the balance sheet. Since peaking during the third quarter of 2018 through increased sales and internal rebalancing, we have reduced Huttig-Grip fastener inventory on average by approximately $1 million per month. Based on our sales trends, we believe there's an opportunity to rationalize an additional $7 million to $10 million in fastener inventory over the intermediate-term.In addition, during the quarter and the first half of 2019, we made meaningful reductions in our cash used for operations and debt. Our two biggest challenges continue to be margin erosion and expense management. Excluding the quarter-over-quarter or year-over-year anomalies, we have quantified financial improvement opportunities across the business of more than $10 million in both gross profit and operating expense. Bob and I are working closely with the corporate and field management teams to simultaneously execute against those opportunities to provide meaningful improvement in the financial performance of the company. While achieving those improvements will require work and take some level of time, we believe we can begin to achieve some level of improvement over the course of the balance of 2019.While I may have overestimated the organization's readiness and ability to effectively execute such a complex shift in our strategy, the most difficult aspects of implementing and executing our growth strategies are behind us. While this transformational process has negatively impacted our financial performance over the past two years, with the exception of the lessons we have learned, we are done looking backwards. As operators and financial managers, it is our primary collective responsibility to consistently increase the value of the company. And we are single-mindedly focused on executing against those opportunities in front of us to continue to grow and diversify our revenue stream and improve the financial performance of the business through recapturing the erosion in our margins and OpEx structure. It is what we get paid to do and we are all accountable to our stakeholders for our performance.Operators, we will now take questions.

[Operator:]

Thank you [Operator Instructions]. And our first question comes from the line of Alan Weber with Robboti Advisor. Your line is now open.

[Alan Weber:]

So Jon, if you can just talk about the Huttig-Grip in terms of -- I don't know if it's the number of conversions. But just how you seeing kind of - -what you see is the trend there and what you hope to accomplish there over the next year?

[Jon Vrabely:]

Well, Alan, I will you tell you that, in general, with regards to our focus of both diversifying amongst our targeted growth customer segments, as well as penetrating our core -- historical core customer segments. With the exception of what we saw in Q2 with regards to our targeted growth customer segments buying ahead of the incremental 15% tariff. We continue to grow double-digits in penetrating how our core customer segment with Huttig-Grip fasteners. So, we continue, as Bob stated, to pick to more shelf space in our packaged and bulk programs and quality of programs, particularly to pro lumber dealers. That is critically important because it is where we have the opportunity to generate the products to use of the entire product category out of warehouse. And it offers the opportunity for us to continue to gain incremental margin in that customer segment across the entire Huttig-Grip fasteners category.So where do we see it's going over the course of the next year, we are just scratching the surface with the penetration efforts. As we mentioned on previous calls, we were late in being able to pursue growth in that very important customer segment until heading into 2019. Are we pleased with where we are? Never. But are we making any significant progress across all of the lumber dealer and core customer segments? We are. And we see nothing at this point in time that would dampen our belief that we will continue to penetrate our core customer segment.

[Alan Weber:]

And do you think when you look at '19 -- I mean how will '20 change in terms of the opportunity to grow? Could you -- you had talked previously that in '18, you weren't set up to really aggressively market and '19 should have the opportunity. How will that change going into '20?

[Jon Vrabely:]

So I think we're -- again, I think as with any new product lines, particularly one as expenses as the Huttig-Grip fastener expansion. I think customers in general fall into three categories. I think they fall into -- the first category would be, we are very happy with who we are currently doing business with as there is not an opportunity for us to grow with Huttig in that category. That's one end of the range. On the other end of the range is we are so happy that you have entered this category, and can provide us with a viable option, because we are not happy at all with our current provider and we are going to convert our business as rapidly as you are in a position to service our business, that's on the other end of the spectrum.The majority of customers, as we continue to demonstrate that we are a viable national option in this category and can be incredibly competitive, both from a cost perspective and a service perspective, the majority of the customers fall somewhere in the middle of those two book ends. And there is tremendous opportunity for us to continue to grow, not only with the customers that are the early adopters as they were waiting for an alternate choice to their current suppliers, but there are many customers that are still probably taking a bit of a wait and see approach. And as we continue to gain more and more traction, we will be provided, I believe, the opportunity to continue to penetrate the majority of those customers that fall somewhere in the middle of those two book end ranges.

[Alan Weber:]

My last part was the ERP system. Is there a way to actually quantify what you think with the additional operating expenses as a percentage of revenue or on absolute basis, and what impact it really did have on revenue?

[Jon Vrabely:]

I'll tell you Bob has been much closer to that. So I'm going to turn it to him.

[Bob Furio:]

So as I stated, Alan, it's really difficult to try to quantify that. But what I can give you is a little color at a high level as far as what we've experienced. Certainly, going from a character based to a web based system. Our previous system was over 20 years old. So it's a massive change of behavior at the field level, as far as order entry and the daily administrative tasks that take place. What we have seen though where we have felt the biggest impact is specifically around our production categories with doors. If you think about the hundreds of thousands of different combinations that could potentially take place with a specific door or door order, that's massive.So in addition to just the administrative tasks of doing order entry, the mapping of all those components is also extremely complex. And while we did a phenomenal job, as far as getting the majority of that work done. So you really go live and you start dealing with individual orders, because so many of them are, in fact, unique is when some of these other issues surface, predominantly around that being. So that's what we've been faced with. And that's what we continue to be faced with. But we are working through those on a daily basis and the amounts that are presenting themselves is certainly decreasing.Overall, I would tell you that our IT team did a phenomenal job, as far as getting this program implemented and the system implemented. Because as you know, system upgrades can potentially bring businesses to their knees. And I would like -- I don't want to use the word seamless, because it certainly wasn't seamless but it was certainly a very smooth transition where we were able to pick up very quickly once we went live May 13th.

[Alan Weber:]

And so is this mostly we're going to see over the next year or two going to show-up in reduced operating expenses. Where is it really going to show-up the most?

[Bob Furio:]

Well, Alan, I would tell you that first and foremost, it is going to provide significant stability to the system. Todd mentioned the character based system that we were on certainly was functional. But the backbone infrastructure to support that system began to truly come into question from a reliability and maintenance perspective. So the upgrade first and foremost provides us with the opportunity to ensure that we are operating on certainly current technology from an infrastructure perspective, and eliminate all of the risks that we were potentially facing around, do we have the right backbone hardware infrastructure to continue to support the operation of our current ERP system.Many of the databases that were used to support the old version were no longer supported by the manufacturers, they were -- the technology was old, the manufacturers of those database systems have moved on causing potential risk. So we, first and foremost, eliminated those risks to the business and those risks to the system. I will tell you that the functionality of the current system also provides significant opportunities for us to better control aspects of the business with regards to purchasing. And while the functionality of the system is very similar, the way in which we actually achieve what we need to do, I think will get better over time as people adapt to the new system and become more familiar with it.To try to quantify whether what the -- if there's potential efficiencies or reduction in operating costs associated with the ERP replacement, it will be much easier for us to bolt-on a new financial reporting package through the new system, because our current financial reporting package, Oracle Financial Analyzer, is again dated and no longer supported. So moving to this system will allow us to next, focus on upgrading, and selecting and replacing an outdated financial reporting package, which we are in the process revaluating and implementing right now on the heels of the ERP conversion.It'll also allows the opportunity to look at bolting-on warehouse management system, potentially more automated acceptance or work orders from the production facility, automated acceptance of shipping tickets, which historically have all been manually entered. So first step is, let's get through this transition process right now. Make sure that we have all of the bugs worked out, particularly around the production of exterior doors and the complexity of that, as Bob said. And once all of the users of the current upgraded ERP system are fully engaged, and educated and engrossed in utilizing that system and that transition has taken place, then we will begin to look for opportunities to begin to drive efficiencies through the use of the new system.

[Operator:]

Thank you [Operator Instructions]

[Jon Vrabely:]

Thank you, Operator. In closing, we remain committed to turning Huttig into a more diversified, profitable company that possess growth opportunities above that of the residential construction markets for many years into the future. I would like to thank all of the Huttig associates for the dedication and hard work they have put forth on behalf of our stakeholders. I also want to thank our customers and supply partners for the trust they place in us each and every day to care for their business. Finally, I thank you for your interest and ownership in our company and for your participation in our call today. We look forward to speaking with you again in October when we report our third quarter results.

[Operator:]

Ladies and gentleman, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.