Huttig Building Products, Inc.
Q3 2018 Earnings Call Transcript

Published: 30 Oct 2018

[Operator:]

Good morning, and welcome to the Huttig Building Products Third Quarter 2018 Earnings Call. Participants will be in 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 Phil Keipp. Please, go ahead, sir.

[Phil Keipp:]

Thank you, and welcome to Huttig’s third quarter 2018 earnings call. As previously announced I have rejoined the company as Vice President and Chief Financial Officer when I served in that capacity from July 2009 through June 2015. I am excited to be back and work with the senior leadership team and the organization to help drive the execution of our strategic growth initiatives. 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 third quarter operating and financial results and provide commentary on our progress and executing our strategic growth initiatives. Following prepared remarks, the call will be opened up 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 in this call as a result of developments that occur afterward. Also, to the extent you are listening to this call on a 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 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 website at www.huttig.com. Today’s call is being webcast live and 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 website under Financials. And now, it is my pleasure to turn the call over to Bob.

[Bob Furio:]

Good morning and thank you for joining our third quarter 2018 earnings call. I will provide a financial update on our strategic growth initiatives and Phil with discuss our financial performance in the quarter and for the first nine months of the year. As previously stated, since embarking on the accelerated growth strategy in early 2017, our goal is to transform Huttig into a more diversified company, making us less susceptible to the volatility of the new residential construction market, while simultaneously creating significant sustainable above market growth opportunities for many years into the future. To that end, we have invested in growth initiatives to expand our value add door fabrication services as well as product line additions and expansions. The investments we have made off of the opportunity to continue to grow in the traditional market segments we currently serve with our core customers, while simultaneously positioning us to grow in a variety of products, market segments and customer segments that have historically not been core to our business. Even though, we are still in the early stages of implementing and executing our transformational growth strategy, our total sales growth in the third quarter of 2018 of 11.2% and year-to-date growth of 12.1% has clearly demonstrated that strategy is working. Based on our market segment revenue mix we have and continued to grow at a rate that is approximately twice that of the residential construction markets we serve. Growth from the investments we made in our strategic initiatives accounted for over 60% of our total growth to quarter. We estimate that revenue growth to core customers was approximately 8%, while growth to non-core customers was approximately 39%. We believe this illustrates our continued expansion into non-traditional customer segments, while also illustrating the remaining growth opportunities with our core customer base. During the third quarter, we grew our pre-finished door revenue by 38%. On a year-to-date basis, we grew our pre-finished revenue by 30%. The investments we made in our pre-finished capabilities have increased our capacity to grow our revenues in this value add service. As we have stated on prior calls, Huttig sold all of the products today are part of the Huttig-Grip product line prior to launching the national expansion initiative in early 2017. However, they were sold on a limited geographical basis and in many cases we did not cover the full breadth of the category. To put our Huttig-Grip growth into perspective since launching the initiative, our incremental revenue growth of Huttig-Grip products in the third quarter of 2018 was 65% over the third quarter of 2017 and nearly double the 2016 third quarter sales of approximately $16 million prior to launching the initiative. Our incremental Huttig-Grip growth in the third quarter of 2018 was approximately 136% of the total incremental growth and Huttig-Grip products achieved in all of 2017. On a year-to-date basis, 2018 Huttig-Grip revenue was up 81% over prior year comparable sales of approximately $50 million. We continued to close – I’m sorry, we continue to work to close the profitability gap associated with the Huttig-Grip expansion plan. In the third quarter of 2017, incremental gross profit dollars from incremental Huttig-Grip revenue covered approximately 11% of the same period incremental investment costs. In the fourth quarter of 2017, the coverage ratio increased to approximately 28%. In 2018, the coverage ratio increased to 44% in Q1, 54% in Q2 and 58% in Q3. In the third quarter, we refined our cost estimates based on non-recurring costs and integration of certain Huttig-Grip and core functions. We are currently reviewing our cost structure for opportunities to expedite incremental cost coverage. John will discuss this more in detail later in the call. Now, I’d like to turn the call over to Phil to discuss our financial performance.

[Phil Keipp:]

Thank you, Bob. Third quarter 2018 net sales were $222 million, which was $22.4 million or 11.2% higher than the third quarter 2017. Through the first nine months of 2018, net sales were $643.4 million, which was $69.4 million or 12.1% higher than 2017. By comparison based on our segment revenue mix, we believe our sales growth was 6.7% in excess of market in the third quarter and 6.4% above market year-to-date. Revenue increase in the quarter and on a year-to-date basis was primarily attributed to an increase in residential construction activity as well as organic growth derived from the execution of our growth initiatives. We grew all product classifications in the third quarter and through the first nine months of 2018 as compared to 2017. Gross margins were 20.1% of net sales during the third quarter of 2018 compared to 20.7% during the prior year period. Through the first nine months of 2018, gross margins were 19.9% of sales compared to 20.7% during the prior year period. The 60 point basis reduction in gross margin percent during the quarter and the 80 point basis reduction year-to-date were largely driven by an increase in direct sales volumes as well as the proportional increase in building products sales as compared to the growth and other higher margin product categories. Our operating expenses were $41.1 million during the third quarter of 2018 compared to $38.2 million during the third quarter of 2017. Personnel costs increased approximately $1.5 million, primarily as a result of wage increases, higher variable compensation, higher health care costs and additional sales and warehouse personnel related to the execution of our strategic growth initiatives. Non-personnel costs increased $1.4 million, primarily as a result of higher fuel prices, increased contract haul costs and higher facility costs. As a percentage of sales, operating expenses were 18.5% in the third quarter of 2018, compared to 19.1% in the third quarter of 2017. Absent litigation costs from the PrimeSource matter which was settled in the second quarter of 2018, our operating expense ratio would have been 18.5% in both years. Year-to-date, operating expenses were $123.2 million compared to $113.3 million in 2017. The increase in operating expenses on a year-to-date basis were driven by the same factors that impacted the increase in the quarter with the addition of higher litigation and litigation settlement costs. As a percentage of sales, operating expenses were 19.1% in 2018 compared to 19.7% in 2017. Excluding expenses associated with the aforementioned PrimeSource litigation and settlement matter, our year-to-date operating expense ration would have been 18.6% in 2018, compared to 19.3% in the prior year period. Net income from continuing operations was $1.2 million during the third quarter of 2018 as compared to net income from continuing operations of $1.3 million in the third quarter of 2017. Adjusted EBITDA was $5.5 million during the third quarter of 2018 as compared to $6.2 million for the third quarter of 2017. Year-to-date, we generated net income from continuing operations of $900,000 as compared to net income of $2.7 million in 2017. Adjusted EBITDA was $14.3 million through the first nine months of 2018 as compared to $13.4 million of 2017, an increase of $900,000 or 6.7% over the prior year. Turning to the balance sheet. We ended the quarter with total debt of $168.3 million compared to $103 million at the end of December 2017 and $103.5 million at the end of September 2017. We generated approximately $13.1 million in cash from operations for the quarter, third quarter 2018 as compared to $6.2 million in the prior year period. At September 30, 2018, net inventory was approximately $153.7 million as compared to $111.9 million at the end of December 2017, and $108.1 million at the end of September 2017. The increase in debt is primarily related to the initial inventory build required to support the Huttig-Grip initiative, as well as the traditional seasonal increase in inventory and accounts receivable. Additionally, certain products are sourced overseas and require shorter payment terms to suppliers. We are sharply focused on rightsizing our inventories as the initial inventory build of Huttig-Grip products coupled with a slower than expected sales execution rate has resulted in lower returns as compared to our historical performance. These products typically requiring longer lead time and thus on hand quantities are generally higher than core product requirements in order to support anticipated demand. Now, I will turn the call over to Jon for closing comments.

[Jon Vrabely:]

Thank you, Phil. As we approached the end of 2018, we are nearly two years into the implementation of our growth and diversification strategic plan. To reiterate the magnitude of this endeavor, over the course of 2017, we centralized, developed, branding and packaging, increased our warehouse space by over 350,000 square feet, purchased and installed over $1 million of new racking, established a global supply chain organization, vetted and established sources of supply with nearly 100 new international supply partners procured, received inventory, created marketing collateral and pricing, and increased our sales force by approximately 35 people to be in the position to simultaneously increase our product offering by more than 1,000 new skews across all of our locations. Even though, we are still in the early stages of executing in organic growth strategy of this magnitude. Our revenue growth since launching our national sales plan nine months ago, clearly demonstrates that we have successfully built the foundation to transform Huttig into a more diversified company that possesses the ability to grow above the market for many years into the future. We had truly just scratched the surface in terms of the size of this opportunity and since rolling out our growth initiatives to the market nine short months ago, we have grown our revenue at or above twice that of the market growth. While we are pleased that the market has responded so positively to our expanded value add services and products offering. And that they have rewarded us with meaningful share gains in a short period of time. We have yet to successfully achieve our targeted operating leverage. To ensure, we could adequately service the incremental revenue we generated, we took a conservative approach and added more operating expense and inventory during the initial implementation phase of the strategy. That approach combined with the operating inefficiencies associated with implementing a growth initiative of this magnitude resulted in our inability to leverage our incremental revenue into incremental profitability. Over the first nine months of 2018, we have gained a clearer understanding of the service and inventory requirements necessary for the continued execution of our growth initiatives. As such, we are taking action to right size our expense structure and inventory levels in order to better leverage our growth and increase our profitability. We have gained some level of operating efficiencies in 2018, as our growth has become the new normal and we are confident that we can successfully continue to grow at an accelerated rate above the market while simultaneously reducing costs and inventory that was layered into the organization during the initial implementation of the strategy. To this end, we are implementing plans to generate operating margins in 2019 that will be more in line with our historical performance prior to our recent infrastructure built. The structure is in place to support future sales growth and we expect to improve our operating leverage as we continue to transform Huttig into a more diversified growth oriented company. We believe this transformation will result in the creation of a company that breaks through the financial constraints of large commodity type distribution businesses and will establish a new financial model that creates a significant value for our shareholders. Operator, we will now take questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Greg Eisen of Singular Research. Your line is open.

[Greg Eisen:]

Thank you. Good morning. You talked about the rightsizing of the expenses and inventory, can you describe the timeframe over which that will occur is that – it’s not an instantaneous thing obviously, but how long will that drag out to take place over?

[Phil Keipp:]

Good Morning, Greg. So we are working on them right now and plan to certainly begin the implementation of both the rightsizing of the OpEx structure and we have already been working on the reduction of our inventory. So our goal is to have that quantified and implemented, certainly as we head into the first quarter of 2019.

[Greg Eisen:]

So as the first – as you get into the beginning of next year, you should have it underway. I understand that. And the expense reductions that I could estimate that based upon your prior margin level, which is what your target is for next year, but inventory itself does it lead directly into your operating margin per se? It’s an interest cost, but can you describe the range of how much cash do you think you can pull out of inventory, as well as what your debt reduction expectations are going forward between now and the end of 2019?

[Phil Keipp:]

I can tell you that, every year as we head into the – what I would call, the non-seasonal part of the business. We have successfully in the past been able to bring our inventory levels down in Q4. We are certainly, planning on doing that again this year and in addition to what I would call our core kind of inventory levels, we certainly believe that we have more Huttig-Grip inventory than we need today, particularly in the fastener category. So we are targeting, reductions in the Huttig-Grip fastener category in the $15 million to $20 million range. We believe that if we can bring our inventory’s down in Huttig-Grip fasteners by that level in the – what I would call the near-term, meaning certainly within the next 90 to 150 days. And we should be able to continue to achieve the type of growth that we’ve achieved throughout 2019 potentially even accelerate that growth heading in – I’m sorry, in 2018, potentially accelerate that growth heading into 2019 and not need to add a significant amount of inventory to the system to be able to achieve that growth.

[Greg Eisen:]

I get it. Thank you very much for answering my question. I’ll let someone else go.

[Operator:]

Thank you. [Operator Instructions] At this time, I’m showing no further questions. I’d like to turn the call back over to Jon Vrabely for any closing remarks

[Jon Vrabely:]

Thank you, operator. In the phase of the stress, we have placed on the organization and the challenges we have faced and continue to face. It is an exciting – it is exciting to see the type of growth we have achieved through the first nine months of this year. While we still have a lot of work to do with the startup in infrastructure build behind us, we can finally focus on what our organization and management team does best as operators. I am proud of what we’ve achieved during a difficult period of change, and I would like to thank all of the Huttig associates for their hard work and dedication. I also want to thank our customers and supply partners for the trust they place in us every day. Finally, I thank you for your interest in ownership in the company and for your participation in the call today. We look forward to speaking with you again when we report our full year results.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program and you may all disconnect. Everyone have a great day.