Earnings Call Transcript - GFF Q2 2022

Operator, Operator

Greetings and welcome to Griffon Corporation's Second Quarter 2022 Earnings Conference Call. As a reminder, participants are in listen-only mode and a question and answer session will follow the formal presentation. I would like to turn the conference over to your host, Brian Harris, Chief Financial Officer of Griffon Corporation. Please go ahead.

Brian Harris, CFO

Thank you, Bickrum. 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. We 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, CEO

Thank you and good morning everyone. We had record sales, adjusted EBITDA, and adjusted EPS in the second quarter. Our performance was driven by pricing and product mix, led by our Home and Building Products segment and the contribution from the January 24th, 2022 acquisition of Hunter Fan. We've made significant progress with price realization during this quarter. These pricing actions, along with fixed cost leverage, have resulted in increases in sales and profitability. Revenue has increased by 36%, adjusted EBITDA more than doubled, and adjusted EPS is almost tripled year-over-year. Our businesses and the global economy continue to navigate a challenging environment regarding labor, supply chain, transportation issues, and inflation. Our employees have worked tirelessly to manage through these obstacles and have generated outstanding results. We thank all of them for their efforts. From a strategic perspective, we closed the acquisition of Hunter Fan this quarter. There was strong demand in our new Term Loan B facility. And as a result, we were able to finance the acquisition on favorable terms. We're in the early stages of integrating Hunter into the rest of the CPP segment and we're pleased with the Hunter team's performance. The business has been performing as expected, and we continue to be enthusiastic about the strategic fit of Hunter. Last week, we announced that we entered into a definitive agreement to sell Telephonics to TTM Technologies for $330 million or approximately $300 million after-tax. Pending regulatory approvals and certain closing conditions, we expect to close the transaction by June 30th. The sale of Telephonics will increase long-term value for our shareholders by strengthening our balance sheet. Turning to our segments, during the quarter, Consumer and Professional products made progress in reaching price cost parity. These efforts, coupled with our focus on more attractive products and categories, resulted in strong price and mix for the quarter. Unfavorable weather conditions year-to-date have resulted in a slow start to our spring selling season and, as expected, volume has also declined from customer supplier diversification. On an organic basis, these declines mostly offset the benefits from improved price and mix during the quarter. Our AMES strategic initiative, which we initiated in November 2019, has made steady progress. We consolidated five manufacturing and distribution facilities, rationalizing approximately 800 thousand square feet of facility footprint in the process. We recently consolidated two other facilities in Reno, Nevada, into new expanded West Coast distribution and digital commerce fulfillment center. We opened an East Coast Digital Commerce fulfillment center in Carlisle, Pennsylvania and successfully implemented a new business system and business intelligence platform. Building out the new and upgraded East Coast and West Coast fulfillment distribution centers was a big step for positioning us for the future. And the successful initial implementation of the business system and business intelligence capabilities in the United States establishes a solid foundation for our global operations. The fact that the team was able to accomplish all this during the course of the pandemic is quite remarkable and speaks volumes about their skills and commitments to making the initiative a success. According to our original plan, the next major step with the AMES initiative was to establish a new manufacturing and distribution facility and further consolidate existing facilities into that new operation. Keep in mind, we originally blueprinted these strategic actions before COVID, as planning activities progressed, untenable construction schedules and equipment procurement lead times along with a significant increase in costs for the build-out of a new facility and the procurement of specialized manufacturing equipment resulted in unacceptable return on investment. In light of these evolving factors, we've decided to reduce the scope of the AMES strategic initiative. We'll conclude the current activities by September 30 of this year, which is one year earlier than originally anticipated. At its conclusion, the initiative will have a cost of $65 million, which is half of the original $130 million. When fully implemented and the efficiencies are realized, we now anticipate annual savings of $25 million compared to the original expectation of $30 million to $35 million. By any measure, this is a more efficient strategy for improving our cost structure and competitiveness. Let's shift to our Home and Building Products businesses. Continued customer demand, along with the team's successful efforts to address price cost parity, led to the strong results for the quarter. Our residential door business demand continues to be healthy thanks to sustained repair and remodeling activity, higher home prices, and continued builder activity. Price and mix were particularly strong with these products. Due to the ongoing labor shortages and supply chain disruptions, residential door volume decreased in the quarter and the backlog continues to be significantly greater than historical levels. The commercial door business continues to see favorable pricing and mix as well as increased volume. I'll remind you that our acquisition of CornellCookson in 2018 diversified and strengthened our commercial offerings in anticipation of volume growth and margin improvement. Fast-forward, our leading commercial door business today is performing well and we expect further growth. Let's go to the 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 quarterly dividends. Our net debt to EBITDA currently stands at 4.4 times. Using proceeds from the anticipated sale of Telephonics, coupled with strong second half operating results, and the free cash flow generation, we expect to significantly de-lever and end the year with leverage less than three times. Additionally, we have ample liquidity with $122 million in cash and $233 million available on our revolving credit facility. Finally, yesterday our Board authorized a $0.09 per share dividend payable on June 16th, 2022, to shareholders of record on May 19th, 2022. This marks the 43rd consecutive quarterly dividend to shareholders, which has grown at an annualized compound rate of 17% since we first initiated it in 2012.

Brian Harris, CFO

Let me turn it over to Brian who will take you through some of the financials. Thank you, Ron. I'll start by highlighting our second quarter consolidated performance on a continuing basis. Revenue increased by 36% to $780 million, and adjusted EBITDA more than doubled to $140 million, both in comparison to the prior year quarter. Adjusted EBITDA margin was 17.9%. Gross profit on a GAAP basis for the quarter was $261 million compared to $161 million in the prior-year quarter. Excluding restructuring-related charges and acquisition write-up of inventory, as applicable, from both years, gross profit was $266 million in the current quarter, increasing 62% over the prior-year quarter, with a gross margin of 34.1%. Second quarter GAAP selling, general, and administrative expenses were $158 million compared to $118 million in the prior-year. Excluding adjusting items from both periods, selling general and administrative expenses were $144 million, or 18.5% of revenue compared to $113 million or 19.7% in the prior-year quarter. Second quarter GAAP income from continuing operations was $59 million or $1.10 per share compared to the prior year period of $18 million or $0.34 per share. Excluding adjusting items from both periods, current quarter adjusted net income was $73 million or $1.37 per share compared to the prior year of $25 million or $0.47 per share on a continuing basis. Corporate and unallocated expenses excluding depreciation were $12.8 million in the quarter compared to $12.1 million in the prior-year. Our normalized effective tax rate, excluding adjusting items for the quarter, was 28.3%, and for the year-to-date period was 29%. Capital spending was $11.5 million in the second quarter compared to $8.8 million in the prior year. Depreciation and amortization totaled $16.3 million for the second quarter compared to $13.1 million in the prior year. Regarding our segment performance, revenue for CPP increased over the prior year by 24%. Hunter Fan contributed $71 million, or 21%. Excluding Hunter, revenue increased 3% due to favorable price and mix of 15%, partially offset by unfavorable volume of 11% primarily due to U.S. demand, and unfavorable foreign exchange. Adjusted EBITDA increased over the prior year by 28% due to the $14 million contribution from Hunter and favorable pricing mix, partially offset by the unfavorable impact of reduced U.S. volume and increased costs for labor, materials, and transportation. HBP revenue increased 52% over the prior year quarter due to favorable pricing and mixes for both commercial and residential products. Increased commercial volume was offset by decreased residential volume. Adjusted EBITDA increased 161% compared to the prior year quarter, driven by increased revenue and fixed cost leverage, partially offset by increased costs for labor, materials, and transportation. As Ron mentioned earlier, we're accelerating the AMES strategic initiatives and concluding the effort at the end of fiscal 2022. Our revised forecast for the initiative will be approximately $50 million of one-time charges and $15 million in capital expenditures, net of expected proceeds from the sale of exited facilities compared to the original expectation of $65 million in expenses and $65 million of capital investments, or in total, half the cost. When fully implemented and the efficiencies are fully realized, we now expect annual savings of $25 million compared to the original expectations of $30 million to $35 million. Remaining expenditures after the end of fiscal 2022, including those related to deployment of AMES’ global information systems, will be included in the continuing operations of the business. Future investments in equipment, particularly for automation, will be included as part of the normal course, annual capital expenditures. During the second quarter, AMES incurred pretax restructuring-related charges of approximately $4.8 million in capital expenditure of $900,000 supporting the AMES initiative. Regarding our balance sheet and liquidity as of March 31, 2022, we had net debt of $1.8 billion and leverage of 4.4 times as calculated based on our debt covenants. The increased leverage from the prior quarter of 3.3 times is related to the Hunter acquisition that we closed in January, and the $800 million Term Loan B facility that we secured to finance the transaction. We plan to use the $300 million of net proceeds from the sale of Telephonics to pay down debt, and that contribution along with free cash flow generated in the second half of our year and our expected EBITDA results should result in a leverage ratio less than three times, which is below our target of 3.5 times. As a reminder, Griffon uses cash in the first six months of its fiscal year, which we more than offset by the generation of significant cash flow in the second half. Regarding our 2022 guidance. In February, we provided updated guidance for revenue of $2.75 billion and segment adjusted EBITDA of $355 million for fiscal 2022. That reflected the additional contribution of Hunter Fan for only eight months of fiscal 2022. As a result of our out-performance in the first half of the year and with consideration to current market conditions, we are updating our fiscal 2022 guidance. We now expect on a continuing operations basis, which includes the eight-month contribution from Hunter and excludes Telephonics revenue of $2.85 billion and segment adjusted EBITDA of $475 million. The increase in revenue and EBITDA guidance is driven by the continued benefit of price and mix at HBP in the second half, partially offset by softer demand at AMES in the CPP segment. Included in our guidance and consistent with the Q1 update, we continue to expect a Hunter contribution for the eight months of fiscal 2022 in which we owned the business to be $250 million of revenue and $55 million of EBITDA, excluding the effects of the acquisition-related costs and purchase accounting. We continue to expect Hunter to contribute $400 million of revenue and $90 million of EBITDA for fiscal 2023. The EBITDA guidance excludes unallocated costs of approximately $49 million and one-time charges of approximately $15 million related to the AMES initiative, as well as charges related to the proxy, Hunter-related acquisitions expenses, and Telephonics related divestiture expenses. Total capital expenditures for fiscal year 2022 are expected to be $55 million, which now includes approximately $5 million supporting the AMES initiative and $5 million for the addition of Hunter. Depreciation and amortization are expected to be $68 million, of which $18 million is amortization. These are inclusive of approximately $5 million of depreciation and $8 million of amortization related to Hunter. We expect net interest expense, inclusive of the financing for Hunter, of approximately $83 million for fiscal 2022. Our expected normalized continuing operations tax rate including Hunter will be approximately 29%. As is always the case, geographic earnings mix and any legislative action, including new guidance on tax reform matters may impact rates.

Ron Kramer, CEO

Now I'll turn the call back over to Ron. Thanks, Brian. The Griffon team continues to be extremely active executing on our strategic actions to build shareholder value. At the halfway point in the year, we have already completed the largest acquisition in Griffon's history with the Hunter Fan Company, a highly complementary business to our CPP segment, financed the Hunter acquisition with new debt security at attractive terms, accelerated the AMES strategic initiative to fundamentally strengthen the CPP business, and signed a definitive agreement to divest Telephonics for $330 million, which will strengthen our balance sheet and allow us to focus our resources. In closing, our management teams continue to successfully navigate an unprecedented set of challenges in the current environment, and despite these challenges, we're raising our guidance as a direct result of the efforts of our talented teams. Our performance this quarter is confirmation of the strength of our strategic plan, resilience of our businesses, and excellence of our operating management. Operator, we'll take any questions.

Operator, Operator

Thank you very much. At this time, we'll begin our question-and-answer session. A confirmation tone will indicate your line is in the question queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment, please, while we pause for questions. As a reminder, we ask that you limit yourself to one question and one follow-up.

Bob Labick, Analyst

Good morning. Congratulations on outstanding results.

Ron Kramer, CEO

Thanks, Bob. Good morning.

Bob Labick, Analyst

I'm still trying to understand everything. It's impressive, but could we start with HBP? Could you elaborate a bit on the main strengths in commercial and the outlook? What are the factors contributing to this significant increase? What has changed, and how sustainable is this outlook, given that the guidance is considerably higher, including for the second half? Please provide some details on HBP, both in commercial and residential aspects.

Brian Harris, CFO

Sure. So I would start by saying this quarter reflects price cost benefit after multiple quarters of price cost lag. The commercial business continues to see very good demand. Look at the landscape with increasing warehouse space being built, that of course will also lead to future replacements in those types of facilities. Our manufacturing facilities that we expanded back in 2019 have definitely paid off and put us in a position to meet the demand that we're seeing.

Bob Labick, Analyst

Got it. Okay. Great. And then obviously with the strong results, the cash flow, and the favorable proceeds from Telephonics, the targeted leverage at the end of this year is, I guess you said below three times. It's remarkable how fast you're paying down the debt and reducing leverage. Are there other targets for M&A on your horizon right now? Is share repurchase obviously given evaluation or consideration? Or how are you thinking about capital allocation going forward with the rapid deleveraging that's occurring right now?

Ron Kramer, CEO

We've always looked at building long-term value and the acceleration of our cash flow generation is part of what we viewed as a series of acquisitions that were meant to grow the company, de-lever, and position us for future growth. What's clear is that the price of our stock bears no relationship to the value of our business. We closed on Telephonics in this quarter and everything's on the table. We'll take a look at where our cash is and stock buybacks, dividends, we see ourselves as being the cheapest alternative. M&A is always topical for us, but we look at ourselves as being far more opportunistic.

Bob Labick, Analyst

Okay, super, thank you.

Operator, Operator

Thank you. We have the next question from the line of Julio Romero from Sidoti. Please go ahead.

Julio Romero, Analyst

Hey, good morning, everyone.

Ron Kramer, CEO

Morning, Julio.

Brian Harris, CFO

Morning.

Julio Romero, Analyst

HBP showed a very strong performance. Can you provide insights on CPP regarding demand by product line, and also discuss the impact of interest rates on current demand?

Brian Harris, CFO

We are noticing a slight decline in demand, as the spring season is off to a slow start due to weather conditions, especially in the Northeast. Demand has softened a bit, but we believe this is primarily seasonal and temporary. We remain optimistic about the rest of the year. Despite higher interest rates, they are still historically low, and housing demand remains strong amid a significant housing shortage. The long-term outlook for our business is robust. Our strategy focuses on leading brands and essential products, which positions us well for growth alongside the U.S. economy. Although the current economic cycle is uncertain regarding monetary policy and the effects of interest rates, our housing segment has not experienced any drop in demand. We maintain that the housing market is favorable due to the ongoing shortage and the demand drivers related to our home improvement products. We are very positive about the long-term prospects of the CPP segment, and our outlook for Hunter remains unchanged for both the near and long terms. Our products are essential for homes and commercial use, and we are the leading brand across all categories we sell.

Julio Romero, Analyst

Okay, very helpful. And then, I guess my follow-up back to the HBP business, you did see increased commercial volume and reduced residential volume due to labor and some supply chain, but I'm just curious if on the residential side, despite the supply chain issues, if you're seeing more inquiries from the new construction channel and would that be a potential opportunity for Griffon? Thank you.

Brian Harris, CFO

Sure. Yes, new construction certainly is an opportunity for the business. Though we are primarily repair and remodel, we certainly do serve the new construction space, and as well as we don't always actually know where our doors go, particularly from smaller builders. They buy doors from dealers and we don't know where they ultimately end up, but a strong housing market is certainly a positive for the overall HBP residential side of the business.

Operator, Operator

Thank you. We have the next question from Justin Bergner with Gabelli Funds. Please go ahead.

Justin Bergner, Analyst

Good morning, Ron. Good morning, Brian.

Ron Kramer, CEO

Good morning.

Brian Harris, CFO

Morning, Justin.

Justin Bergner, Analyst

Congratulations on the good quarter and improved outlook. I guess to start, I just want to make sure I heard a couple of numbers correctly. So the after-tax proceeds from the defense electronics sale, that's about $300 million?

Brian Harris, CFO

That's correct.

Justin Bergner, Analyst

Okay. And then the new segment adjusted EBITDA guide is $475 million and there's a $55 million contribution from the eight months of Hunter?

Brian Harris, CFO

The $55 million is included in the $475 million.

Justin Bergner, Analyst

Okay. Got it. So now onto the substantive questions. Regarding your new segment adjusted EBITDA guidance, you achieved a little over $150 million in the first quarter, which means the remaining three quarters would amount to about $325 million. Should I perceive the decrease from $150 million this quarter to the projected $105 million to $110 million in the next few quarters as being driven by demand, or is it more related to short-term pricing dynamics and inventory accounting adjustments, with the $105 million to $110 million reflecting the segment EBITDA at current demand levels?

Brian Harris, CFO

Sure. So on the AMES business, we've taken a more conservative posture for the second half of the year on demand regarding the HBP business. We expect continued good revenue and EBITDA, with margin looking like the first half of the year.

Justin Bergner, Analyst

Got it. So look at the first half margins rather than the second quarter as representative for the go-forward.

Brian Harris, CFO

Yes, first half margins.

Justin Bergner, Analyst

Okay. And just one last question on the HBP side. Obviously, you are unable to fully deliver on the residential demand. Do you effectively have a backlog there that priced a few quarters out? At this point, given the strong demand, or how does the next couple of quarters look in terms of catching up to demand that both from a volume point of view and a price cost point of view?

Brian Harris, CFO

We have a significant backlog that we expect to progress on as we move through the rest of this year and into next year, fiscal 2023. There is some lag in price within that backlog, but it is mostly priced at the appropriate level.

Justin Bergner, Analyst

Got it. So the price in margin for HBP is pretty visible for the next couple of quarters? It's only when you get to the next fiscal year that you're going to be filling material, new backlog, and I guess pricing that new?

Brian Harris, CFO

You're thinking about it correctly.

Operator, Operator

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session, and I'd like to turn the call back to Ron Kramer, CEO for closing remarks over to you, sir.

Ron Kramer, CEO

We're doing very well and we expect to continue to do better and we're all hard at work to continue to build shareholder value. Thank you.

Operator, Operator

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.