Huttig Building Products, Inc.
Q1 2017 Earnings Call Transcript

Published: 2 May 2017

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Huttig Building Products First Quarter 2017 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. Just a reminder, this conference is being recorded. I would like to now turn the conference over to your host Vice President and Chief Financial Officer, Mr. Oscar Martinez. Please go ahead, sir.

[Oscar Martinez:]

Thank you, and welcome everyone to our earnings call. With me this morning is Jon Vrabely, President and Chief Executive Officer of Huttig. Today we’ll discuss our operating and financial results for the first quarter of 2017. We’ll also update you on our outlook and growth expectations for the coming years. Following our prepared remarks we’ll open the call for questions. Let me take a moment to remind you that today’s discussion reflections 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 could occur afterwards. Also, to the extent who are listening to this call on a replay information could have already changed. Additional information about factors that could potential impact our financial results is included in the earnings release issued yesterday and our filings with the SEC. During this call we will discuss certain non-GAAP financial measures. A description of any non-GAAP adjustments are reconciliation to the most comparable GAAP measures can be found in the earnings release issued yesterday and on our website. And now, it is my pleasure to turn the call over to Jon Vrabely

[Jon Vrabely:]

Thank you, Oscar. Good morning and thank you for joining us today. The first quarter of 2017 is a tale of two stories for Huttig. The first being the progress we are making in the implementation of our strategic growth plan, and the second being the impact that those investments have had on our financial performance during the quarter. We believe the opportunity exists today during this housing cycle to fundamentally change Huttig for the future and are deeply engaged in making that happen. As I have previously communicated, the goal of our accelerated growth strategy is to build on evaluating accretive acquisitions and investments in organic growth initiatives that results in continued, sustained and meaningful increases in the value of the company. During our call in early March, I detailed the key components of our accelerated growth strategy and I’m pleased to report that we continue to make significant progress in successfully implementing and executing our plans. The continued execution of the strategic plan contributed to our net sales growth of 11% over the first quarter of 2016. In addition, the important and value of the investments we are making to expedite our growth in the repair remodel segment was amplified in the first quarter of 2017. At the single family, new construction segment continues to grow our customers that are focused on that segment will continue to increase their level of direct purchases which generates lower gross margins. As a result, we experienced a meaningful increase in direct sales as a percent of our total revenue. And despite the negative impact of the sales mix shift and the fact that we are in the early stages of growth from our segment penetration and product expansion initiatives, we were successful in maintaining our gross margin of 20.2% as compared to the first quarter of 2016. On the surface, the increase in our operating expenses to $37 million for the quarter may appear disappointing but it reflects the investments we are making in our accelerated growth strategy and I continue to believe these investments will transform our company in the intermediate term. Very simply, we have a comprehensive accelerated growth plan that requires a level of investment to create the capacity and scale to effectively service the planned incremental revenue. To achieve that scale, we successfully added racking and reconfigured 75% of our warehouses, leased additional warehouse space and hired additional resources to expand our warehouses, logistics and sales capabilities. While the quarter-over-quarter expense investment negatively impacted our first quarter 2017 results, approximately 75% of the incremental operating expenses are directly related to the implementation of our accelerated growth strategy. We believe these investments enhance our value proposition as the largest door fabricator to the pro-channel and as the only national wholesale distributor of value add mill work and specialty building products. In addition to enhancing our value proposition, these investments provide a platform for transformational growth that will result in substantial future value creation. As we look to the balance of 2017, we will continue to make the required investments to execute our growth strategies. We believe the housing market will continue to grow and we expect to maintain our share of that growth as housing starts continue to move towards the 30 year historical average of 1.4 million. We believe that our initiatives will continue to propel our overall growth rate above that of the market. We continue to evaluate accretive acquisition opportunities but until now we have determined that the best returns relative to the risk come from continued organic investment. Now I’d like to turn the call back over to Oscar to discuss the income statement and balance sheet.

[Oscar Martinez:]

As Jon indicated, we increased our net sales by 11% compared to the first quarter of last year to $175.7 million while achieving gross margins of 20.2%. Our operating expense was $37 million or 21% of net sales for the quarter compared to 18% in the first quarter 2016. We expect to see ongoing strategic investments as we continue to fully implement our strategies. Simultaneously, we expect that revenue will continue to grow and we believe we will reach sufficient levels of sales to cover our operating expenses in the backhalf of this year and beyond. Throughout this investment phase, we continue to manage our cost structure by focusing in all controllable costs. The results of these investment activities for the first quarter was a net loss from continuing operations of $0.9 million compared to net income of $1.5 million and adjusted EBITDA of $0.1 million compared to $4.2 million for the first quarter of 2016. Turning to the balance sheet. We ended the first quarter of 2017 with total available liquidity of $81.8 million compared to $82.6 million at the end of the first quarter 2016. Working capital was 15.4% of quarterly sales compared to 13.9% in the prior year period. We’re building inventory for the summer selling season and have opportunistically added inventory ahead of expected price increases. Even as we sell through with just the inventory, we anticipate further bills related to our product line expansions in the second and third quarter of 2017. To this point, and as part of our product line expansion initiative, we recently announced national supply agreements with Knauf and [indiscernible] and are currently in the process of placing opening inventory orders to support our sales plan. We have and will continue to use our strong balance sheet as a tool to capture specific sales opportunities with extended credit terms. As long as we continue to monitor credit closely, we believe our balance sheet helps us compete effectively against locally limited competitors that cannot offer the same terms. We ended the first quarter 2017 with total debt to capitalization net of cash of 53% compared to 54% at the end of the first quarter of 2016. Our sole financial covenant is a fixed charge coverage ratio and we’re confident that we’ll continue to comply with this covenant if tested. We’ll continue to invest additional working capital and incur operating expenses as we execute our market segments and product expansion growth initiatives. We expect big things from our accelerated growth strategy and believe that if the underlying fundamentals of the residential housing market continue their current trajectory, we would grow at a faster rate than the market and ultimately, these initiatives - generate over a billion dollars in sales by year end 2019. Operator, I’ll turn it back to you so we can take some questions.

[Operator:]

[Operator Instructions]. And our first question comes from the line of Jim Barrett of C. L. King & Associates.

[Jim Barrett:]

Good morning, everyone.

[Jon Vrabely:]

Good morning, Jim.

[Jim Barrett:]

Jon congratulations on the Knauf relationship. Can you tell me whether you’ll be offering their insulation line nationally? And if so, any range of what the sales potential could be?

[Jon Vrabely:]

We’ll be offering their line nationally in every location Jim that is not mill work exclusive. So, in some trading areas, we have as an example say the state of Maine, where we have a mill work location and a dedicated building products location that service the entire trading area collectively. So not every location will have - in today’s specialty building products or will they be going forward but we anticipate being able to service all of our entire geographical trading areas with the expansion of the product lines. With regards to estimated revenue, since we really do not provide specific guidance in general with regards to revenue projections, certainly we’re not going to begin to provide guidance with regards to specific product categories. We will continue to report revenue at the SEC reporting levels as we do today.

[Jim Barrett:]

Understood. And one question for you Oscar, excluding BenBilt, can you give us broadly speaking, how much of your growth in the quarter is from volume and how much is from passing along higher pricing from your suppliers? And is there any difference between your segment to note?

[Oscar Martinez:]

We try to focus on growth generally, and obviously price component is a big part of it as much as volume. Again, that’s one of those numbers we don’t really break down but I would tell you that we’re happy with the growth that we’re seeing from the business overall both the components that relate to what I would call the legacy business and the components that pertain to the initiatives we’re pursing, right? So that includes BenBilt and the accelerated growth strategies.

[Jim Barrett:]

But you alluded to price increases in the remainder of the year from your vendors, is it a reasonable conclusion to conclude that you’ll be seeing increases from multiple vendors in multiple categories that will need to be passed along?

[Oscar Martinez:]

I mean really it’s – I appreciate the clarity. From an inventory perspective, it’s just part of the annual cycle, right? Not every one of our vendors increases their price every year but in good market conditions like we’re seeing now, I think you’ll expect to see some continued price increases. And in that case, yes, those increases would pass along to customers. It frankly gives the market a chance to resettle a little bit around those new prices.

[Jim Barrett:]

Thank you both.

[Jon Vrabely:]

Hey Jim, just I’ll – too, we have not seen significant price increases from our supply base that would have really like move the needle in any way in Q1.

[Oscar Martinez:]

Yeah, the comment on inventory was just opportunistically here and there, but it’s not across the board.

[Jim Barrett:]

Okay. Thank you both.

[Jon Vrabely:]

Thank you.

[Operator:]

And our next question comes from the line of Brandon Austin of Venesaur[ph] Capital.

[Unidentified Analyst:]

Hey guys. How you’re doing this morning?

[Jon Vrabely:]

Good morning.

[Unidentified Analyst:]

I got question here on your growth. So obviously that was a very big growth quarter for you guys. And did I hear you right, so you guys are currently targeting a billion in revenues in 2019 or by the end of 2019 run rate or what was the target there?

[Oscar Martinez:]

Yeah, we go back to the sort of direction we were talking about in our last call as we execute on the growth initiatives that we’re pursuing, we see an opportunity to capture additional upside. So we do see a billion dollars of revenue by year end 2019.

[Unidentified Analyst:]

By year end, so not in the year 2019 but get that run rate for 2020 I guess or is that 2019?

[Oscar Martinez:]

Correct.

[Unidentified Analyst:]

Pardon?

[Oscar Martinez:]

Yes.

[Unidentified Analyst:]

Okay. But that still assumes that you are going to grow at close to 10% per year for the next couple of years, I realize some of that might be acquisitions but is that a fair characterization?

[Oscar Martinez:]

Correct.

[Unidentified Analyst:]

Okay. And when you get to that billion dollar target, just because I know that the OpEx is sort of I guess the topic of the day here, do you anticipate that you will be able to say, re-achieve your 2016 EBITDA of or adjusted EBITDA of roughly 4%, is that possible?

[Oscar Martinez:]

Yeah, so we look to establish the scale that we need, right and the scale drives the efficiency that gets back to our historical levels. And so we look to reestablish our operating leverage and kind of drive that value now that of course, we’re getting there quickly as we can, right? But the real question becomes exactly how quickly we are? So we’re comfortable giving you guidance at the top-line, the riskier proposition of what EBITDA margins materialize and then a lot of factors that are really outside of our control. So, I don’t know that I’m comfortable getting to that level of detail. That’s our outlook.

[Unidentified Analyst:]

Okay.

[Jon Vrabely:]

We have stated previously that we believe over the intermediate term which we really classify as kind of 12 to 36 month period that we will be able to achieve operating leverage of kind of our historical rate of 7% to 10%. So the conundrum today honestly is that we believe in the plan, we are executing the accelerated growth plan, we believe that it will fundamentally change our organization for the better and create significant value. And the issue really is that we are making investments today to be able to achieve that scale and the push honestly is generating that required level of revenue as rapidly as possible to reach that tipping point where we begin to leverage that incremental revenue at a faster rate than the required investment. And that is the, to be frank, that is the race that we are in right now.

[Unidentified Analyst:]

Okay.

[Oscar Martinez:]

And like we said, as we sort of offer that view it also depends on the underlying market conditions continuously right now because part of the billion dollars is through our growth initiatives, but the bigger part of that is through the recurring revenue of our underlying business. And so, there is a lot of blocking and tackling that goes into that statement and that’s why we are so excited and so aggressively pursuing the initiatives that we keep talking about.

[Unidentified Analyst:]

And I know that in a recent conference you guys were talking about product mix shift and the goal is to put a bigger push on the more profitable products. Can you just explain to me the story that why the gross margin drop back a bit? I guess it was flat with last year but relative to recent quarters, you said something about the direct sales mix.

[Jon Vrabely:]

Yeah, so in Q1, we had a significantly higher mix of direct sales which carry a significantly lower margin than warehouse or production transaction. And that growth in direct mix obviously has a negative impact on your overall gross margin as well as your total gross margin or gross profit percentage. So, we were successful in actually growing our shipping profit percent quarter-over-quarter basis, but as a result of the increased mix in direct, we basically came in at the same level we did in Q1 of 2016.

[Unidentified Analyst:]

Okay. And just last question, can you give bit of an update on your [indiscernible] right, your private label initiative?

[Jon Vrabely:]

Yes, the HuttiGrip…

[Unidentified Analyst:]

HuttiGrip, sorry HuttiGrip, that’s it.

[Jon Vrabely:]

Yes, HuttiGrip product line expansion. So that is basically progressing as planned and that is why you are seeing really the expenditures towards resetting warehouses, adding racking, leasing incremental space, layering in incremental headcount because products are starting to land today and so we need to be in a position to effectively service those products. So I would tell you that it is progressing as planned and at this point in time, I certainly don’t see any achievements[ph] to our continued progress there as we continue to implement and execute that plan throughout the course of ‘17 and into the future.

[Unidentified Analyst:]

Okay. Thanks a lot guys.

[Jon Vrabely:]

Thank you.

[Operator:]

And our next question comes from the line of John Rolfe of Argon Capital.

[John Rolfe:]

Hey, guys. Good morning.

[Jon Vrabely:]

Good morning, John.

[John Rolfe:]

So, I’m probably going to butcher what you said earlier, but I think what you said you expect the incremental revenues from your growth initiatives to offset the increased operating expenses as we get into the backhalf of the year. So I’m hoping you can just put a little more color around that. Is what you mean by that you would expect as we get into the backhalf that we should start seeing operating or EBITDA margins that look similar to the year ago levels or what exactly do you mean when you’re talking about that, that offset in the backhalf of the year?

[Oscar Martinez:]

Yeah, so the problem John is essentially in the first quarter we had more operating expenses relative to our revenue, right?

[John Rolfe:]

Yes.

[Oscar Martinez:]

So as a result, the mix -- the operating expense ratio was higher than we would like it to see and we think as we establish the business, starting the backhalf of the year like you said, we’ll get back to an operating expense ratio that is closer to historical standards. And basically the point is just generate enough revenue from these initiatives to be able to afford the fixed cost that we’re layering in.

[John Rolfe:]

Okay, got it. So if I look at full year 2016, you guys had an operating expense ratio of 18%, so operating expenses were equal to 18% of revenues and what you’re saying, just to confirm, is that as we get into the backhalf, you would hope to get that operating expense percentage back to something approximating that 18% once again?

[Oscar Martinez:]

Right. And acknowledging that in the first quarter is where we are and then, working as quickly as possible, I don’t know that we’d get there for the full year, but certainly as we look at the quarterly numbers, that’s the plan that we have.

[John Rolfe:]

Okay, great. Thanks very much. Appreciate it.

[Oscar Martinez:]

Absolutely.

[Operator:]

And our final question comes from the line of Alan Weber of Robotti Advisors.

[Alan Weber:]

Good morning.

[Jon Vrabely:]

Good morning, Alan.

[Alan Weber:]

Hi. When you talk about the gross margin and the direct shipment, was that the main factor impacting, kind of the flattish gross margin percent?

[Jon Vrabely:]

Yes, in total, as our mix shifted in ‘17 Q1 as compared to ‘16 Q1, we saw a fairly significant mix shift in ‘17 towards more direct volume. And obviously direct volume carries a significantly lower gross margin percentage at that transactional level than warehouse or production margins. So, we saw at the kind of individual transactional level amongst production shipping profit levels, warehouse shipping profit level and even direct shipping profit levels on an individual kind of transaction type basis, Alan, all of those shipping profits were up compared to Q1 of ‘16 but the cumulative impact of the faster growth in direct obviously negatively pulled down the total gross profit generation to the same level that we were at in 2016.

[Alan Weber:]

Right. And I guess it was actually reduces the operating expenses a little bit also.

[Jon Vrabely:]

Well in, what I would say, in a non-significant investment period, you would probably see -- you would see that. The dilemma for us today or the challenge is that we are in a truly a transformational growth period which is requiring that significant level of investment on the front end to create the capacity and really, truly get ourselves ready to effectively handle the incremental revenue.

[Oscar Martinez:]

It also would be, obviously helpful if we had a crystal ball and know today what the direct sales were going to be for the full second quarter, but even though we have good insights, we don’t have that current visibility. So that stacking levels on the operating expense as you would assume would be there based on historical levels is what the individual branches sort of plan on when they make their own plans, right? So you’re right theoretically that as we see more direction, as we can be more confident that more of the business is going to directs, then we can staff appropriately. But obviously the - needs to be staffed up for the levels of business that they expect based on prior year experience and based on the best insights they have as to what the market’s going to do.

[Alan Weber:]

And I guess Jon, one other question, you’ve talked about the growth and the HuttiGrip and like that, and I don’t know if the level of operating expense being where they are today is greater than what you would have thought three or four months ago. But it sounds like it’s all coming together – is it coming together faster than you actually initially expected?

[Jon Vrabely:]

I would say, Alan, honestly that as much as I would love to tell you oh yes, coming together faster, I would say realistically, we are pretty much right on plan. I mean we are kind of where we thought we would be. I think the real challenge around the OpEx number is -- it is very difficult to literally headcount by headcount particularly across the hourly workforce to determine well how much of that individual warehouse person’s time at that location was spent servicing the existing legacy business or how much of that person’s time was spent setting up racking or moving product or breaking down equipment? And so, cumulatively, we know that we had more expense and more headcount than what was necessary to service the existing business, but we are only going to have one opportunity to truly execute these various growth initiatives. And the last thing that we want to do is not be ready to flawlessly service the opportunities that come our way from the customer base as we roll out either the new products or the enhanced service capabilities across our pre-finished lines. So it does require a significant initial investment to make sure that we are in a position to flawlessly execute that growth strategy.

[Alan Weber:]

Okay. Jon, I realize it makes the quarterly, on these calls a little more complicated, but it seems financially so much better off for the shareholder than if you just had made an acquisition, right? Because that’s what you’re really doing is just trying to develop a subsidiary comparable to of the German side acquisition.

[Jon Vrabely:]

Yeah, the product line expansion strategy is honestly beyond HuttiGrip. I mean the HuttiGrip expansion is certainly a piece of our overall product line expansion strategy, but it’s really all of the growth initiatives that we are implementing and executing simultaneously. And I have to tell you our folks are doing an incredible job of staying focused on as close to flawless implementation and execution of all of those strategies. So we think from a growth perspective, all of them cumulatively provide this truly transformational kind of growth opportunity.

[Oscar Martinez:]

Alan, the other thing I would tell you is when we see a small private company with $5 million of EBITDA up for sale expecting a double-digit multiple of EBITDA on their purchase price, it kind of brings into light the risk reward equation that we’re seeing right? Because that’s a negligible acquisition relative to the scale of what the initiatives we’re pursuing can provide at a much more expensive price tag for the shareholders. And frankly, we think that the best asset we have right now is the value of the growth opportunity for the business. We think that’s what will propel the equity over time. But to use the equity at these levels for bigger acquisitions, to me, seems like an expensive proposition.

[Alan Weber:]

No, I agree 100%, this just makes it a little more complicated on these type of calls. However, because we make an acquisition, it’s almost like a one-time thing, you take some write-offs, restructuring charges, the usual stuff. And then people kind of quickly do a pro forma and this is not going to take that long for us to see, if from now we’re going to see the results less than a if-now.

[Jon Vrabely:]

Yes, sir.

[Alan Weber:]

Okay, great.

[Jon Vrabely:]

Thank you.

[Alan Weber:]

Thank you.

[Operator:]

At this time, there are no further questions.

[Jon Vrabely:]

Thank you, operator. This is a pivotal and exciting time as we continue to lay the groundwork to transform Huttig into what we wanted to be, not just what it is today or what it can be tomorrow by riding the growth of the housing market, but what we truly wanted to be in the future. We continue to believe that through the execution of our strategic plan, that we are creating a diversified company that will consistently grow above the market, generate sustained earnings growth and increased value for all Huttig’s stakeholders. In closing, I again want to thank all of the Huttig associates for their contributions to our continued success. I also want to thank our customers and our supply partners for the trust they place in us every day to care for their business. Lastly, I thank you for your interest and ownership in our company and your participation in our call today. Thank you very much.

[Operator:]

Ladies and gentlemen, this conference will be available for replay after 12 PM today through May 9, 2017. You may access the AT&T replay system at anytime by dialing 1-800-475-6701 and entering the access code 422409. International participants, please dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844 using access code 422409. That does conclude our service for today. Thank you for using AT&T Executive Teleconferencing. You may now disconnect