Earnings Call Transcript - GFF Q2 2023

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the Griffon Corporation Fiscal Second Quarter 2023 Earnings Conference Call. This call is being recorded on Wednesday, May 3, 2023. I would now like to turn the conference over to Mr. Brian Harris, Chief Financial Officer. Please go ahead, sir.

Brian Harris, CFO

Thank you. Good morning, 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 reporting 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, Chairman and CEO

Thanks, Brian. Good morning, everyone, and thank you for being here. This is our first earnings call since we started our strategic alternatives review process, so there’s much to cover. I will begin by discussing our strategic review process and its outcome, followed by an overview of our operating results, expectations for the year, and our future strategy. We announced the beginning of this process in May 2022, but it actually started earlier in January 2022 when we formed a committee on strategic considerations and engaged our advisors, Goldman Sachs and Dechert. This committee, made up solely of independent Board members, was tasked with working alongside our advisors to evaluate a range of strategic alternatives aimed at maximizing shareholder value, including a potential sale, merger, divestiture, or recapitalization. Throughout 2022 and into 2023, Griffon and its advisors explored various strategic options and engaged with a variety of potential partners to identify those that could deliver significant value to our shareholders. After thorough review and discussion, the Griffon Board agreed unanimously that none of the alternatives we considered appropriately reflected Griffon's strong operating performance and growth potential. Consequently, the Board decided that our best strategy for maximizing shareholder value at this time is to continue focusing on our strategic plan. This decision reflects our Board’s confidence in Griffon’s trajectory and strategic direction. Due to the confidential nature of this process, we cannot share specific details about the options explored or negotiations undertaken. However, the fact that the process spanned over a year from initiation to conclusion indicates its comprehensiveness during a period of rapidly changing economic and financial conditions. Now that the process is concluded, we maintain that there is a significant disparity between our stock price and the intrinsic value of our businesses, and we are committed to implementing a series of actions to deliver further value to our shareholders. I want to emphasize that while we are no longer actively seeking strategic alternatives, we remain open to considering any opportunities that can enhance shareholder value. Turning to our operating results, Griffon's performance in the first half of 2023 has surpassed our expectations. Our results were primarily driven by the Home and Building Products segment, which continues to see growth in commercial volume and improved pricing and mix across all products and channels. Although residential volume has declined year-over-year, it performed better than we had anticipated. The HBP team successfully addressed the sectional door backlog that had built up over the past two years, and our factories are now functioning with normalized backlog and lead times. This improvement allows the HBP team to concentrate on enhancing productivity and expanding business development efforts that had previously been hindered by backlog and longer lead times. The team is intensifying its efforts to capture more residential and commercial business by boosting marketing initiatives and leveraging our strong positions in sectional and rolling steel product offerings, complemented by a portfolio of innovative products that are well-received by customers. I want to express my gratitude to the HBP team for their exceptional performance and dedication to growing this business. The performance of our Consumer and Professional Products division continues to reflect the challenging retail market conditions we face. All CPP channels and regions are experiencing diminished consumer demand and elevated customer inventory levels. This situation is particularly difficult in the U.S. lawn and garden and storage and organizational markets, where customer supplier diversification has influenced buying choices, in some cases worsening softness in consumer demand. The combination of lower volumes and unfavorable manufacturing and overhead absorption has adversely affected operating leverage, resulting in losses for some of CPP's U.S. product lines. In response to these changing market conditions, CPP is broadening its global sourcing strategy to include long-handled tools, material handling, and wood storage and organization products currently manufactured in the U.S. for sale domestically. The CPP team will utilize its extensive global sourcing expertise to manage this transition using a cost-effective asset-light structure. This approach will position CPP's U.S. operations to better serve customers with a more flexible and efficient sourcing model, enabling cost management and responsiveness to variable demand, ultimately enhancing future profitability. These initiatives will allow CPP to continue delivering high-quality products, leveraging our well-known brands, while reinforcing our competitive advantage with industry-leading distribution and service that our customers expect. Furthermore, these actions are part of CPP's ongoing evolution, positioning this segment to achieve targeted EBITDA margins of 15% and generating substantial added value for our shareholders. Now, regarding our guidance for the year, our strong performance in the first half has exceeded our expectations. As such, we are raising our full-year segment EBITDA guidance to at least $525 million, up from the earlier forecast of $500 million. Earlier today, the Griffon Board announced a 25% increase in our regular quarterly dividend, in addition to a $2 per share special dividend and an increase in our share buyback authorization to $258 million, which was approved by the Board two weeks ago. These decisions underscore our commitment to enhancing both short-term and long-term value for our shareholders and reflect the confidence that Griffon's Board and Management have in our strategic plan and prospects. Now, I will hand it over to Brian to discuss some of the financials.

Brian Harris, CFO

Thank you, Ron. I'll start by discussing our second quarter consolidated continuing basis performance. Revenue of $711 million decreased by 9% and EBITDA before our unallocated amounts of $152 million decreased by 1%, both in comparison to the prior-year quarter. Adjusted EBITDA margin was 21%, increasing approximately 180 basis points year-over-year. Gross profit on a GAAP basis for the quarter was $194 million compared to $261 million in the prior-year quarter. Excluding restructuring-related charges and the acquisition write-off of inventory, gross profit was $269 million in the current quarter, increasing 1% over the prior-year quarter. Gross margin increased year-over-year by 275 basis points to 37.9%. Second quarter GAAP selling, general, and administrative expenses were $160 million compared to $158 million in the prior year. Excluding adjusting items from both periods, selling, general, and administrative expenses were $150 million representing 21.1% of revenue compared to the prior year of $144 million or 18.5% of revenue. Second quarter GAAP loss from continuing operations was $62 million or $1.17 per share compared to the prior year period income of $58 million or $1.09 per share. This decline was primarily driven by charges related to the CPP's intangible asset impairments and global sourcing expansion. Excluding all items that affect comparability from both periods, current quarter adjusted net income from continuing operations was $67 million or $1.21 per share compared to the prior year of $73 million or $1.36 per share. In the quarter, we recorded a non-cash impairment charge for indefinite lived intangible assets of $100 million or $74 million net of tax. The charges resulted in CPP's year-to-date expected 2023 results being below expectations. Corporate and unallocated expenses, excluding depreciation, were $14.6 million in the quarter compared to $13.1 million in the prior year. Our normalized effective tax rate, excluding adjusting items for the quarter were 29.5% and 29.4% for the year-to-date period. Capital spending was $7.1 million in the second quarter compared to $11.5 million in the prior year quarter, depreciation and amortization totaled $17.3 million for the second quarter compared to $16.3 million in the prior year. Regarding our segment performance, revenue for Consumer and Professional Products decreased 24% from the prior year, with organic revenue decreasing 29%. The reduction in revenue is primarily attributable to reduced volume across all channels and geographies driven by soft consumer demand and elevated customer inventory levels. These items were partially offset by a full quarter of Hunter revenue as well as favorable price and mix. CPP adjusted EBITDA decreased from the prior year by 59% primarily due to the unfavorable impact of reduced volume and revenue and its related impact on manufacturing and overhead absorption. These items were partially offset by reduced discretionary spending and a full quarter of Hunter contribution. Home and Building Products revenue increased 8% over the prior-year quarter, driven by favorable pricing and mix for both commercial and residential products. Total volume decreased due to decreased residential volume, partially offset by increased commercial volume. Adjusted EBITDA increased 26% compared to the prior year quarter, driven by increased revenue and reduced material costs, partially offset by increased costs for labor, transportation, advertising, and marketing. As mentioned earlier and detailed in our press release, CPP is expanding its global sourcing strategy for products manufactured and sold in the U.S. The project includes the closure of four manufacturing facilities and four wood mills. We expect to complete this project by the end of calendar 2024. In that period, we will incur charges of $120 million to $130 million including $50 million to $55 million in cash charges for employee retention and severance operational transition and facility costs, and $70 million to $75 million of non-cash charges primarily related to asset write-downs. We also expect capital expenditures in the range of $3 million to $5 million. These charges exclude the benefit of cash proceeds from the sale of owned real estate and equipment, which are expected to largely offset the cash charges and also exclude inefficiencies due to duplicative labor costs and absorption impacts during transition. In both the quarter and six months ended March 31, 2023, CPP incurred pre-tax charges of $78.3 million related to the expansion of the global sourcing strategy consisting of cash charges of $19.2 million and non-cash asset-related charges of $59.1 million. Regarding our balance sheet and liquidity, as of March 31, 2023, we had net debt of $1.3 billion and net debt to EBITDA leverage of 2.5 times as calculated based on our debt covenants. Compared to $1.4 billion of net debt and 2.7 times leverage in the previous quarter. Regarding our 2023 guidance, we are updating our expectations for revenue and segment-adjusted EBITDA. We now expect 2023 revenue of $2.7 billion compared to previous guidance of $2.95 billion as a result of decreased CPP revenue, partially offset by increased HBP revenue, adjusted EBITDA in 2023 is now expected to be at least $525 million compared to our previous estimate of at least $500 million. Our EBITDA guidance excludes unallocated costs of $56 million and charges related to the strategic review process of $22 million, which is an increase from our prior guidance of $16 million, as well as CPP's global sourcing expansion charges. Our increased adjusted EBITDA expectations reflect strong HBP results, partially offset by the reduced CPP volume mentioned earlier. Guidance for other metrics remain unchanged for 2023 including free cash flow to exceed net income, capital expenditures of $50 million, depreciation of $50 million, amortization of $22 million, interest expense of $103 million, and normalized tax rate approximating 29%. As Ron mentioned earlier, Griffon's Board of Directors authorized a 25% increase to our quarterly dividend to $0.125 per share payable on June 15, 2023, to shareholders of record as of May 25th. On April 20, the Board approved an increase to our share repurchase authorization to $200 million, bringing the total outstanding authorization to $258 million.

Ron Kramer, Chairman and CEO

Thanks, Brian. I want to highlight that despite our businesses continuing to navigate in an uncertain global macroeconomic environment, our employees have maintained high levels of customer service and product quality. We thank each of them for their efforts. We are very confident about our future. Home and Building Products continues to perform well and with HBP's return to normal operations after the pandemic surge, the business is now able to focus on growth and productivity initiatives. We continue to see long-term tailwinds for the business driven by healthy demand for our commercial products and the historically resilient repair and remodeling market for our residential products. We are also confident about the prospects for our Consumer and Professional Products segment. While CPP is currently working through challenging conditions, we expect the business environment will stabilize over time, allowing CPP to deliver significantly improved financial results. Griffon's Board and Management have strong conviction in our outlook and strategic plan as demonstrated by the significant increase in our dividends and expanded stock buyback authorization. We will continue to use the strong operating performance of our business and its free cash flow to deliver long-term value to our shareholders. We believe our best days are ahead of us. Operator, we'll take any questions.

Operator, Operator

Thank you, Mr. Kramer. Ladies and gentlemen, we will now begin the question-and-answer session. Your first question comes from Bob Labick with CJS Securities. Please go ahead.

Bob Labick, Analyst

Good morning. It's nice to talk to you again.

Ron Kramer, Chairman and CEO

Good morning, Bob.

Bob Labick, Analyst

Congratulations on your continued strong performance. There are many questions to ask, so I will keep it brief and get back in the queue. Starting with HBP, the performance has been outstanding and difficult to predict. Clearly, margins have significantly improved due to mixed pricing and the operational efficiencies you have achieved over the past year. Can you provide insight into what the new normal range for operating margins in the doors segment might be? Additionally, could you clarify if there has been an overbuilding phase in the current demand cycle and what normalized margins might look like for this business in the next few years?

Ron Kramer, Chairman and CEO

Let me start by saying that building the company gets lost in moments in time and you have to go back and recognize that we have been on a five-year journey of building the Clopay business. We bought Cornell Cookson going on five years ago, and we had three years of COVID. We were doing well pre-COVID. We had a plan of improving margins that was working. We've come out of COVID, we have grown our commercial business, our team has done an extraordinary job of managing the integration of the acquisition and the expansion of our commercial business to balance the already leading residential business that we have. We are positioned for residential and commercial growth; our business is not dependent on new home construction; it is driven by repair and remodel on the residential side. New home construction, which continues to be in a shortage in this country, will only benefit us. The commercial business has grown and will continue to grow, and while this quarter is clearly the best margin quarter that we've ever had in HBP, we continue to see strength and sustainability of the business. Where that will shake out in terms of margin only time will tell but we have a business that finished last year with $412 million of EBITDA and will be better than that this year. That's why we have confidence in raising our guidance and we believe due to the sustainability and the resilience of the business going forward that this is a defendable business with higher margins than we've enjoyed over prior cycles. Brian, do you want to add to that?

Brian Harris, CFO

I think you summarized it pretty well unless Bob you have additional questions.

Bob Labick, Analyst

No, that's super helpful. I appreciate you taking a step back. We have been observing this journey since Cornell Cookson, including the integration and expansion. Could you provide insight into the commercial market opportunity, detailing where you have been growing and where you are aiming for further growth now that you are fully integrated and ready to pursue it?

Brian Harris, CFO

Sure, I'll start with that. The commercial market has been strong and continue to see good results from that side of the market from our historical legacy products as well as the new products that we've come up with over the last couple of years. In addition to that, we are getting great benefits out of leveraging the history of the legacy Cornell Cookson dealers and bringing on our sectional commercial product into those dealers, and there's still much of that to capture in the future. Some of that was on pause over the last two years as our backlog was elevated, and now that our backlog and our lead times are normalized, we are going to be back out there and getting after that business. Of course, things like warehouse spaces and institutional-type operations are where we see most of our business.

Operator, Operator

Thank you. Your next question comes from Tim Wojs with Baird. Please go ahead.

Tim Wojs, Analyst

Hi guys, good morning. Good to hear from you again.

Ron Kramer, Chairman and CEO

Hi, Tim.

Tim Wojs, Analyst

Hello, maybe just the first one on maybe CPP as it relates just to maybe level set us in terms of kind of where that business after all the changes kind of lands from a revenue perspective on a normalized basis.

Ron Kramer, Chairman and CEO

Sure. So, as we go through this process and come out the other side at the end of '24, we see this as a $1 billion-plus size revenue business that will be generating 15% level margin.

Tim Wojs, Analyst

Okay. And then maybe just on the cash flow, kind of a two-part, I guess firstly cash flow supposed to be better than net income. But it's already kind of meaningfully better this year. So, I guess is it possible that it's pretty meaningfully higher relative to net income. And then I guess where the stock is today, I mean, how aggressive would you be with the stock here, just given the expanded buyback?

Brian Harris, CFO

Sure. Let me start by answering the cash flow question, yes, we are seeing very good cash flow, especially in the first half of the year, where generally we don't have much cash flow in the first half of the year, so it can be meaningfully better than net income as you pointed out. But we stick with our stated better than net income, which falls under that category.

Ron Kramer, Chairman and CEO

And let me just add, start with our balance sheet, we don't have a debt maturity until '28 and we have substantial free cash flow, we've authorized $258 million, stay tuned.

Operator, Operator

Thank you. Your next question comes from Noah Merkousko with Stephens. Please go ahead.

Noah Merkousko, Analyst

Good morning, and thanks for taking my questions.

Ron Kramer, Chairman and CEO

Good morning.

Noah Merkousko, Analyst

First, I wanted to talk on HBP kind of just get an update on how you're seeing demand at least through the balance of the year, especially now that backlogs are normalized, I'd imagine that would limit your visibility somewhat. So, I guess how do you get confidence in the demand there for commercial and residential R&R?

Brian Harris, CFO

Sure. On the residential side, volume is below where we've seen it last year, but it's in the resilient repair and remodel market, and actually the volume has been a little better than we originally expected, which leads to raising our guidance. On the commercial side, we continue to see strong volume, our products are doing well, and I referenced back to us going after commercial sectional business, leveraging our legacy Cornell Cookson relationship.

Ron Kramer, Chairman and CEO

And the other point I'll make is in our pricing has and we expect it to continue to hold.

Noah Merkousko, Analyst

Got it. That's really helpful. Switching gears to the CPP side, you've announced that you're expanding your global sourcing strategy and we should expect 15% EBITDA margins in '24, but at what point?

Brian Harris, CFO

'25.

Noah Merkousko, Analyst

At what point would you expect this strategy to start bearing fruit and becoming accretive to segment margins?

Brian Harris, CFO

Yes. So, '24 will remain a transitional period as we move over these particular product lines to sourcing model and those benefits will come through in '25; we expect it to take until roughly the end of calendar '24.

Operator, Operator

Your next question comes from Sam Darkatsh with Raymond James. Please go ahead.

Sam Darkatsh, Analyst

Good morning, Ron. Good morning, Brian, how are you?

Ron Kramer, Chairman and CEO

Doing well. How are you, Sam?

Sam Darkatsh, Analyst

I'm well. As well, and it's good to hear your voices certainly on a formal basis. So, a couple of questions and I'm actually have three or four maybe I'll get back into the queue if possible. So, the $250 million authorization, if you do it at least by my math on the open market, that could take years depending on the daily volume, why wouldn't you consider a tender or an ASR to put that money to work while the stock is at current levels?

Ron Kramer, Chairman and CEO

We don't think it will take years and we will consider any and all possibilities, but we are not able to be in the market until we put out our earnings. Let 48 hours go by, and I believe that means starting on Friday. Expect us to be in the market.

Sam Darkatsh, Analyst

Got you. And then the retention payouts, Brian, do they continue or how are they going to be accounted for now that the strategic review process is concluded, at least for the time being?

Brian Harris, CFO

Yes. We will continue to highlight those amounts, as they represent a specific event over several years. These payments will occur each third quarter for this year, next year, and the following year.

Operator, Operator

Thank you. There are no further questions at this time, Mr. Kramer, back over to you.

Ron Kramer, Chairman and CEO

No, I think Sam has some more questions.

Sam Darkatsh, Analyst

Hello. Am I on?

Ron Kramer, Chairman and CEO

Yes.

Sam Darkatsh, Analyst

Can you hear me okay?

Ron Kramer, Chairman and CEO

Yes.

Sam Darkatsh, Analyst

Okay, terrific. Sorry about that. My last question again getting back to the CPP sourcing, which is fascinating. So, where specifically are you contemplating moving the sourcing from a geographic standpoint, is that going to be kind of a sole contract OEM manufacturing setup like you have with Hunter? How do you manage risk with that type of setup, if you could help us put a little meat on the bone in terms of what the plans are at this point.

Ron Kramer, Chairman and CEO

Well, let me start by saying this is an evolution and a continuation of what we do globally. We have a global sourcing office in China, we have facilities that we already work with; our Australian business is part of that global sourcing, our U.K. business is part of global sourcing. The evolution of our U.S. operations, and our aggressive approach to repositioning it based on what's changed in the consumer markets, you correctly point out our Hunter relationship and that is a design in the United States and manufactured elsewhere for distribution in the United States. So, I view what we're doing to our CPP business as an evolution of what we've done successfully at very attractive margins globally, to be able to fix a business in the U.S. that has a very high manufacturing overhead that can be supported other than being on an outsourced global sourcing model.

Brian Harris, CFO

Yes. I'll just add to that; global sourcing truly means global sourcing that includes sourcing in South and Central America, the U.S. as well as Asia, and it's not going to be sole-sourced to one person or one entity and in fact using entities against each other in further periods will give us even more advantage.

Sam Darkatsh, Analyst

Is there an issue around the potential for challenged lead times based on some of the seasonality of some of these products? I thought that was one of the primary reasons why there was an appeal to a North American production footprint, especially around long-handle tools, whereby you're able to have high fill rates during the heavy selling season. How does that impact? I'm guessing you might move that type of production to Mexico, or is that also contemplated in Asia? I'm just trying to get a sense of how to manage risk, especially knowing that you still may look to monetize the CPP business at some point, making it still palatable for a potential suitor.

Brian Harris, CFO

Sure. So, you touched upon, part of it will be sourcing from possibly closer areas such as Central America. Further, we will leverage our distribution footprint and keep enough inventory on hand to ensure that we provide the same levels of service to our customers that we have been able to do in the past.

Sam Darkatsh, Analyst

Got you. And then if I'm still on.

Ron Kramer, Chairman and CEO

You are.

Sam Darkatsh, Analyst

Okay, terrific that you're able to speak publicly again. After the repo authorization has been completed, what do you anticipate the debt leverage either at that point or optimally for the business?

Brian Harris, CFO

So, it will depend on when those buybacks occur. Generally, we don't expect leverage to get much above 3x type of level as we’ll be generating cash flow as we're buying shares.

Ron Kramer, Chairman and CEO

As we continue to generate cash, we're in a luxurious balance sheet position, we've got both undrawn bank capital, we've got no debt maturity as I said earlier till '28, we've got free cash flow, and we've got a very undervalued stock that we have every intention of taking advantage of. We've always been in the acquisition business, we're going to be acquiring as much of us as we can with free cash flow for the foreseeable future.

Sam Darkatsh, Analyst

Terrific to hear. And again, terrific to hear your folks' voices. So, we'll be in touch soon.

Ron Kramer, Chairman and CEO

Thank you.

Brian Harris, CFO

Thank you.

Operator, Operator

Thank you, Sam. There are no further questions.

Ron Kramer, Chairman and CEO

Okay. Well, thank you all, and I look forward to speaking to you after our next quarter in early August.

Operator, Operator

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.