Earnings Call Transcript - GFF Q2 2021

Operator, Operator

Greetings. And welcome to Griffon Corporation's Second Quarter 2021 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. I would now like to turn the conference over to your host, Brian Harris. Thank you. You may begin.

Brian Harris, Host

Thank you, Rob. Good afternoon, everyone. With me on the call is Ron Kramer, our Chairman and Chief Executive Officer. Our call is being recorded and will be available for playback, the details of which are in our press release issued earlier today. As in the past, our comments will include forward-looking statements about the company's performance based on our views of Griffon's businesses and the environments in which they operate. Such statements are subject to inherent risks and uncertainties that can change as the world changes. Please see the cautionary statements in today's press release and in our various Securities and Exchange Commission filings. Finally, some of today's remarks will adjust for those items that affect comparability between periods. These items are explained in our non-GAAP reconciliations included in our press release. Now I'll turn the call over to Ron.

Ron Kramer, CEO

Thanks. Good afternoon, everyone. We’re off to a great start in the first half of fiscal 2021 with our second quarter revenue increasing 12%, adjusted EBITDA up 41%, and adjusted EPS up 109% compared to the prior year quarter. These results were driven by continued demand for our comprehensive consumer product categories and supported by a strong housing market and repair and remodel activity. Our strategic actions to optimize our business remain on plan, and we are realizing the early benefits of this work today. Highlighting this success is our increased cash generation profile, coupled with our EBITDA margin expansion in both CPP and HBP, which increased 220 and 190 basis points, respectively, over the prior year period. Our AMES strategic initiative is progressing on plan and on budget. As previously announced, this investment will consolidate operations, increase automation, support e-commerce growth, and create a new data and analytics platform for AMES globally by the end of 2023. We expect this to further improve margins in the years ahead. As we move into our second year of managing our business during a global pandemic, we prioritize protecting our employees, and we’ll continue to do so as restrictions in the United States begin to ease. Turning to our segments. In Consumer and Professional Products, we saw continued retail demand across all geographies and product lines. The AMES strategic initiative remains on schedule for completion by the end of 2023. We reiterate our expectation to realize annual cash savings of $30 million to $35 million and inventory reductions of the same magnitude when the benefits of the initiative are fully realized. In the Home and Building Products segment, we continue to see healthy demand for both residential and commercial door products, and we continue to see demand outstripping supply. In Defense Electronics, Telephonics revenue and profitability decreased from the prior year, primarily driven by reduced volume due to the timing of work performed and deliveries on certain communications and surveillance programs, as well as the divestiture of Systems Engineering Group, SEG. Telephonics' actions to improve its operational efficiency continue with the work to consolidate three facilities into two, which will be completed in our fiscal fourth quarter. Earlier this month, Telephonics was awarded a $162 million five-year support contract from Lockheed Martin for our multi-mode maritime surveillance radars for the U.S. Navy’s MH-60R maritime helicopters. We continue to see additional opportunities for our products in domestic applications, as well as through the MH-60 Romeo foreign military sales to countries like South Korea and Greece. Backlog in the quarter was $354 million with trailing 12-month book-to-bill of 1.1 times. Turning to our balance sheet. We continue to have excellent flexibility in our capital structure to execute on organic and acquisition opportunities and return cash to shareholders through our quarterly dividends. We’ve delevered to 3.1 times net debt-to-EBITDA marking two full turns of improvement over the prior year period. Additionally, we have $176 million in cash and $363 million available on our revolving credit facility, providing ample liquidity and putting us in an excellent position to capitalize on our active pipeline of acquisition opportunities. Earlier today, our Board authorized an $0.08 per share dividend payable on June 17, 2021, to shareholders of record on May 20, 2021. This marks the 39th consecutive quarterly dividend to shareholders, which has grown at an annualized compound rate of 17% since we initiated it in 2012. Griffon has evolved over the past decade from a decentralized holding company to a highly centralized, operations-focused conglomerate. We see growth through acquisitions driving our future, capitalizing on our strong bench of management talent. And regarding our management, Steve Lynch, the President of Clopay Corporation, will retire at the end of our fiscal year. Steve has served as the President of Clopay with distinction for the past 12 years and has been part of Clopay since 2001. During his tenure, Steve navigated Clopay through the financial crisis of 2009 and subsequently has transformed the business into the industry leader it is today through building the company’s facilities, equipment, products, technologies, people, and culture. Steve will continue working with Clopay as a consultant after his retirement. Effective with Steve’s retirement, Vic Weldon will be appointed the new President of Clopay. Vic is a 20-year veteran of Clopay, having served in leadership roles across the business, including supply chain, logistics, sales, and operations, and has been Clopay’s Chief Operating Officer since 2019. Vic has played an instrumental role in making Clopay the company that it is today, including leading the integration activities of the CornellCookson acquisition, which we completed in 2018. Vic is the ideal candidate to assume the role of President where he can apply his wealth of company, customer, and industry knowledge to the role. We’re looking forward to Vic continuing Clopay’s success. Let me turn it over to Brian, who will take you through some of the financials.

Brian Harris, Host

Thank you, Ron. I’ll start by highlighting our second quarter consolidated performance. Revenue increased by 12% to $635 million and adjusted EBITDA increased 41% to $67.8 million, both in comparison to the prior year quarter. Adjusted EBITDA margin increased 220 basis points to 10.7%. Gross profit on a GAAP basis for the quarter was $170 million, increasing 12% over the prior year quarter. Excluding restructuring-related charges, gross profit was $174 million, increasing 13.2% over the prior year quarter, with gross margin increasing 30 basis points to 27.4%. Second quarter GAAP selling, general, administrative expenses were $127 million, compared to $226 million in the prior year quarter. Excluding restructuring-related charges from both periods, selling, general, and administrative expenses were $123 million or 19.3% of revenue, compared to $122 million or 21.5% in the prior year quarter. Second quarter GAAP net income was $17 million or $0.32 per share, compared to the prior year period of $1 million or $0.02 per share. Excluding items that affect comparability from both periods, the current quarter adjusted net income was $25 million or $0.48 per share, compared to $10 million in the prior year or $0.23 per share. Corporate and unallocated expenses excluding depreciation were $12 million in the current year quarter, in line with the prior year second quarter. Effective tax rate excluding items that affect comparability from all periods for the quarter was 30%, and for the year-to-date period, it was 31.1%. Capital spending was $12 million in the second quarter, compared to $9 million in the prior year quarter. Depreciation and amortization totaled $15.9 million for the second quarter, compared to $15.7 million in the prior year second quarter. Regarding our segment performance, Q2 revenue for CPP and HBP increased over the prior year quarter by 21% and 16%, respectively, while DE decreased 26% or 19% excluding the impact of the SEG disposition. Adjusted EBITDA for CPP and HBP increased over the prior year by 50% and 31%, respectively; Defense Electronics decreased 48%. During the second quarter, AMES incurred pre-tax restructuring-related charges of approximately $7.5 million supporting the AMES strategic initiative. Capital expenditures supporting the initiative were $3.2 million in the quarter. At Telephonics, we are executing on our efficiency initiatives. We have reduced headcount, and we expect to complete the consolidation of our three Long Island-based facilities into two company-owned facilities by the end of this fiscal year. The total cost for the facility consolidation will be approximately $4 million, which will primarily consist of capital expenditures occurring in 2021. Regarding our balance sheet and liquidity. As of March 31, 2021, we had net debt of $883 million and leverage of 3.1 times as calculated based on our debt covenants. This is a 2-turn reduction from our prior year second quarter and a 0.3-turn reduction from our fiscal year end. As a reminder, Griffon uses cash in the first six months of its fiscal year, which will be more than offset by the generation of significant cash flow in the second half of the year. Our cash and equivalents were $176 million, and debt outstanding was $1.06 billion. Borrowing availability under the revolving credit facility was $360 million subject to certain loan covenants. So regarding our 2021 guidance, as most of you know, we typically provide guidance once a year during our November earnings call and generally do not update that guidance during the course of the year. The guidance provided on our November call was revenue of approximately $2.4 billion and adjusted EBITDA, excluding unallocated one-time charges related to AMES and Telephonics initiative, of $285 million or better. With our second quarter behind us, we are continuing to see healthy demand for products across our portfolio. Recovering consumer activity and a strong housing market are contributing to a constructive macroeconomic environment, and homeowner focus on outdoor living and repair and remodel projects continues. While we are seeing the expected headwinds from cost inflation, some supply chain disruptions, and a tight labor market, we are managing through those effects. As a result of our substantial outperformance in the first half of the year and with consideration to this year’s Q3 and Q4 comparatives to strong prior year quarter results, we are expecting our fiscal 2021 performance will be substantially above our original guidance and in line with our trailing 12 months. That produced approximately $2.5 billion of revenue and $320 million of adjusted EBITDA excluding unallocated and one-time charges. Now I’ll turn the call back over to Ron.

Ron Kramer, CEO

Thanks, Brian. We expect continued growth in the second half of fiscal 2021 driven by a strengthening global economy, a strong housing and repair and remodel environment, coupled with our industry-leading product portfolio. We are active in evaluating potential acquisitions and opportunities to invest in our existing businesses, and are actively exploring ways to further diversify and grow. We’re pleased with the progress we’ve made on driving long-term shareholder value. However, there still are significant benefits to come from completing our strategic initiatives. Finally, I’d like to thank our 7,500 employees for their exceptional dedication, performance, and perseverance throughout this challenging period. Operator, we’ll take any questions.

Operator, Operator

Thank you. Our first question comes from the line of Bob Labick with CJS Securities. Please proceed with your question.

Bob Labick, Analyst

Thank you. Good afternoon, and congratulations on the fantastic first half of the fiscal year.

Ron Kramer, CEO

Thanks, Bob.

Brian Harris, Host

Thanks, Bob.

Bob Labick, Analyst

Did I hear you correctly? You’re actually raising guidance, which is surprising, but anyway, I’ll get to my question. You pointed out very strong margins in CPP and HBP, which are up nicely year-over-year. How does that play out? You mentioned some raw material and supply chain challenges. I think you are better positioned than most in these situations. Can you talk a little bit about how we should think about the margin profile and what you can do to address some of the raw material or supply chain issues?

Brian Harris, Host

Sure. I’ll take this one. A couple of things, we continue to work on our efficiencies as always and work with our vendors. In addition, we have been working on passing price through. Some of that work continues and will continue into Q3, and will have or should have the full benefit of that in our fourth quarter.

Bob Labick, Analyst

Got it. Okay. Great. And then, obviously, you’re still relatively early on in the AMES initiative, but I think you’re still suggesting that there is still room to run in those margins as well. I mean, obviously some fluctuations aside from short-term things? But is that right? We should still expect continued margin expansion from CPP over the next several years?

Brian Harris, Host

Absolutely. We are actively working on that initiative and you will continue to see its benefits, which is our most effective measure of the efforts we are making. We have already begun to experience some of those benefits, even with the additional costs we encountered in Q2. Overall, our gross margin across the businesses increased by approximately 30 basis points.

Ron Kramer, CEO

Bob, it’s Ron. I’ll just add to that. We’ve always talked about building for the long run and that we never worry about things that are happening in the short run that are out of our control. We try to stay focused on all the things that are. So, we have been managing through the initiative that we kicked off for margin improvement before we went into the COVID pandemic. We’ve been able to not just manage our way through, but we’ve been able to prosper as a result of the demand. We are very optimistic about what we have yet to do on a multi-year journey to both improve the margins in the AMES business and continue the margin improvement story at Clopay. Just look at where we were when Steve Lynch became President of Clopay and where we are today as we pass the baton. Margin improvement is part of the core DNA of Griffon, our ability to buy and improve businesses. We’re going to continue to do the work on our Telephonics business and get that back into shape. That will happen as both the top line improves. But we see across our businesses margin improvement as the core of what we’re doing.

Operator, Operator

Our next question comes from the line of Julio Romero with Sidoti & Company. Please proceed with your question.

Julio Romero, Analyst

Hey. Good afternoon, Ron and Brian.

Brian Harris, Host

Hi, Julio.

Julio Romero, Analyst

So I wanted to ask about your Home and Building Products segment. So I know that you turn inventory about four times annually there and I think you value inventory at lower cost or market, just wondering on the margin dynamic there over the next few quarters. Would you be in a position to benefit in the near term and then have margins moderate in that segment heading into the next fiscal year? Just maybe if you could speak to how margin should play out in that segment?

Brian Harris, Host

In general, for the third quarter, as we continue to navigate the timing of the price increase, we might experience some pressure due to the lag of those price increases. However, we expect to see an offset once we move into the fourth quarter and beyond.

Julio Romero, Analyst

Okay. I understand. So, there could be some short-term moderation as they are experiencing delays in price increases. Do you feel confident in your ability to adjust for that?

Brian Harris, Host

Exactly. That will really…

Julio Romero, Analyst

And okay.

Brian Harris, Host

That will really...

Ron Kramer, CEO

That’s really going to play out more toward the back end of this fiscal year. So, but with clearly a confidence level that we chose to take this moment to increase our guidance for the year.

Julio Romero, Analyst

Absolutely. And I guess just my follow-up is, if you could just give us a reminder on the seasonality within that segment. Typically, as I understand it, this is your weakest quarter, is that correct in that segment?

Brian Harris, Host

Sure. Generally, the second and third quarters are the strongest for CPP, but during the pandemic, the situation has been different. The demand has been strong and we expect it to remain strong for the rest of the year.

Operator, Operator

Our next question comes from the line of Josh Chan with Baird. Please proceed with your question.

Josh Chan, Analyst

Good afternoon, Ron and Brian. Congrats on a strong quarter.

Brian Harris, Host

Thanks, Josh. How are you?

Ron Kramer, CEO

Thank you.

Josh Chan, Analyst

Thanks. Good. I appreciate the comments about the expected performance. I think that shows kind of confidence on continued strong execution, so that’s good to see. I guess, my first question is on the sort of the headwinds that you’re mitigating. I mean you talked about offsetting raw materials in the HBP business. But how are you thinking about the same dynamics in the CPP businesses, any difference in terms of cadence and price and when that kind of offsets the raw materials?

Brian Harris, Host

Yeah. It’s similar. So we’re still working the price increases into the third quarter, and there’ll be a lag, so we’ll expect to have that done and the full benefit of it in the fourth quarter. I will also just remind you that we had very good weather last year in Q3 and very strong comps last year Q3 and Q4 for that matter. But our guidance overall says we’ll be in line on the second half of the year.

Josh Chan, Analyst

That’s right. Okay. And then my second question is on your internal inventory, I guess, has stepped up from Q1 to Q2, which I think has happened before, but that’s not that typical. So anything in particular that drove that kind of a higher inventory there?

Brian Harris, Host

There are a couple of factors contributing to this situation. First, we are experiencing increased commodity costs that are affecting our inventory levels. Additionally, there has been a foreign exchange impact from Australia and the U.K. We have also seen some advance orders for our international locations from China and for the U.S. to ensure we have materials and products ready. As many of you are aware, there are delays in receiving goods from China, and our ports are congested. We are proactively addressing this to ensure we can continue to meet our customers' expectations.

Operator, Operator

Our next question comes from Justin Bergner with Gabelli & Company. Please proceed with your question.

Justin Bergner, Analyst

Good afternoon, Ron. Good afternoon, Brian.

Ron Kramer, CEO

Hi Justin.

Brian Harris, Host

Hi Justin.

Justin Bergner, Analyst

Few questions here. I guess just to pick up on the last question. So what are the primary products or materials that you’re importing from China? And just sort of remind me how U.S. centric you are sort of in your manufacturing for CPP versus what you rely on internal, sorry…

Brian Harris, Host

Sure. So CPP 90% of what we sell in North America we make in North America. So when I talk about imports, that’s the other 10%, a lot of that is either components, small components, and some pots and planters. The other part of what I was speaking of is Australia and the U.K. also get products from China in particular and also from other places.

Ron Kramer, CEO

But the core of the company, as Brian said, this is about American manufacturing, and 90% that’s sold in North America is manufactured in North America.

Justin Bergner, Analyst

I understand. Moving to Home and Building Products, you mentioned that demand is currently surpassing supply. Could you elaborate on that? Are there any significant imports that are being impacted by supply chain challenges, which could create an opportunity for you to gain market share due to a better ability to meet demand compared to some of your competitors?

Ron Kramer, CEO

We’re actually suggesting in that comment we have a backlog and that there is such robust consumer and commercial demand that we are able to build a backlog for this business. That gives us some confidence about what we see as the trends that are playing out and have played out, and that’s balanced against the obvious inflationary pressures of steel, wood, freight, and labor which is tight across the country. We are experiencing very strong demand, and we couldn’t be happier about it.

Brian Harris, Host

And for the majority of HBP, their components such as steel are sourced from the U.S.

Operator, Operator

Our next question comes from Keith Hughes with Truist Securities. Please go ahead with your question.

Keith Hughes, Analyst

Thank you. A question on CPP, another strong growth quarter, we are going to start coming against the difficult comps in the next several quarters if you look at the pace of business and maybe your sales in April. Not really looking for guidance here, but just was the retrenchment in sales in those tough comps or is it just that none of them to pull it through for the next several quarters?

Brian Harris, Host

It was a little broken up what you said, but I believe you are just asking what we’re seeing demand-wise. Demand continues to be strong across the board.

Ron Kramer, CEO

And what we’re equally saying is that we expect those trends in pricing pressures to hit more in the third quarter and for us to be able to pass along some of those into the fourth quarter.

Operator, Operator

Our next question comes from the line of Trey Grooms with Stephens. Please proceed with your question.

Trey Grooms, Analyst

Hey. Good afternoon, Ron and Brian, and I have to also give you my congrats on a strong first half.

Brian Harris, Host

Thanks, Trey.

Trey Grooms, Analyst

So I think most of the questions around costs have been kind of beaten to death here, I think, I pretty well get it. But I guess if we’re thinking about kind of switching gears over to the DE, Defense Electronics business, timing issue in the quarter, should we expect this to continue in the fiscal third quarter and fourth quarter? Also, how should we be thinking about the timing of the new contract win when it flows through and the cadence there?

Brian Harris, Host

Sure. Generally, we anticipate a recovery in the second half compared to the first half. There are some delays with certain contracts and the timing of material deliveries, which affects our ability to ship things out. However, the business is performing well; it's just inherently a bit uneven.

Ron Kramer, CEO

We continue to have confidence in the product category, intelligence, surveillance, reconnaissance. This is about building Telephonics for the future. The consolidation of plant facility that we’ve been doing will show through as we get through this year into next year. But we remain very optimistic about Telephonics' core positioning, its products, where it stands with its incumbent position and in the ability to garner some of the foreign military sales that are just less predictable on timing. This is again about building the company and trying to grow into tomorrow.

Trey Grooms, Analyst

Got it. And then just for kind of modeling purposes, as the top line kind of comes back here in the back half with these kind of being lumpy and the timing issues. Would you expect the margins to kind of also rebound back to kind of historical-type expectations?

Ron Kramer, CEO

Yeah. We would expect the margins to improve into the end of the year.

Trey Grooms, Analyst

Perfect. That’s it for me. Thanks, guys.

Brian Harris, Host

Thank you.

Ron Kramer, CEO

Thank you.

Operator, Operator

We have reached the end of the question-and-answer session. At this time, I’d like to turn the call back over to Ron Kramer for closing comments.

Ron Kramer, CEO

Thank you all for joining us. We’ll be working hard and look forward to talking to you in August. Stay safe, stay healthy, everyone. Bye-bye.

Operator, Operator

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