Hamilton Beach Brands Holding Co Q3 FY2020 Earnings Call

Thank you, Lindsay, and good morning, everyone. Welcome to Hamilton Beach Brands Third Quarter 2020 Earnings Call and Webcast. Yesterday after the market closed, we issued our earnings release and filed our 10-Q. Copies have been posted to our website. Our speakers today are Greg Trepp, President and Chief Executive Officer; and Michelle Mosier, Senior Vice President and Chief Financial Officer. Greg and Michelle will discuss our third quarter results and outlook. Also participating in the Q&A will be Scott Tidey. Scott is our Senior Vice President, North America Sales and Marketing for Hamilton Beach Brands. Our presentation today contains forward-looking statements, which are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in either the prepared remarks or during the Q&A. Additional information regarding these risks and uncertainties is available in our earnings release, 10-Q and our annual report on Form 10-K/A for the year ended December 31, 2019. The company disclaims any obligation to update these forward-looking statements, which may not be updated until our next quarterly conference call, if at all. And now I'll turn the call over to Greg.

Thank you, Lou Anne. Good morning, everyone. Thank you for joining us. I will discuss the third quarter shortly, but first, I want to highlight the underlying strength of our business. We had a strong first half, though our third quarter results were disappointing due to a transition to our new ERP system that temporarily hindered shipping at our U.S. distribution center. We anticipate continued strong demand from consumers throughout the latter half of 2020 and into early 2021. Much of the revenue shortfall from the third quarter is projected to move to the fourth quarter as we work to optimize our shipping capabilities and meet market demand. Early indicators for the fourth quarter show shipments exceeding last year’s levels. The issues related to ERP have been resolved. Although the transition was more challenging than anticipated, we now have a more efficient system in place that will serve us well in the future. The small kitchen appliance market in the U.S. and Canada is expanding at about 30% compared to 2019, driven by consumers spending more time at home during the pandemic and preparing meals and beverages more often. We expect this high demand to persist into 2021. Hamilton Beach Brands is in a strong position to meet this unprecedented demand with high customer orders and sufficient inventory available. We've been boosting in-stock levels with our customers and maintaining high shipping volumes. We secured holiday placements, including several new products. Our popular portfolio of consumer-preferred brands is paying off. Despite remote work, our new product development process is functioning effectively. Our strong e-commerce capabilities, global infrastructure, and diverse retailer relationships are key competitive advantages. Additionally, retail business in Mexico and Latin America is slowly recovering. Commercial clients in food service and hospitality sectors are starting to reorder as they adapt to the changed landscape due to the pandemic. We are well-prepared to take advantage of the recovery in these markets. Our financial health is robust, as we have managed net working capital wisely and reduced debt. Moreover, Kitchen Collection's losses and cash flow issues are no longer a concern, as we successfully closed the business earlier this year. That timing has proven to be fortuitous. While we focus on leveraging the positive trends propelling Hamilton Beach forward, let me comment briefly on our third quarter. As noted in our last call, we were in the early stages of transitioning to a new ERP system in the U.S. We previously reported a decline in sales during July and expected to recover that in August and September. However, the challenges in August proved to be more persistent than anticipated. We improved shipping capabilities week by week and were operating more effectively by September. However, the revenue shortfall from July and August was too significant to fully recover in the third quarter. The ERP challenge was the main obstacle, but we also faced shipping and transportation issues, both inbound from suppliers and outbound to customers, which contributed to our revenue shortfall. While the ERP-related shipping challenges have largely been addressed, ongoing congestion in shipping and transportation requires us and our customers to adapt our plans. We’ve enhanced our shipping capabilities by adding warehouse staff and equipment, extending shifts, and using temporary third-party facilities. We also shifted some order volume from our largest retail customers to direct import to alleviate shipping pressure. We are preparing for record direct-to-consumer shipments and are well positioned on retailers' e-commerce sites. With consumers likely to shop online at higher rates, we are set to support our retail partners. A continuous challenge is the global pandemic, which remains a factor for several months. We are attentive to health and safety as we monitor the changing COVID-19 environment globally to keep our business compliant and moving forward. We are thankful for our employees' efforts to stay safe and healthy, especially those who cannot work from home. Our team has successfully navigated this global crisis, showcasing remarkable focus, teamwork, and diligence. I extend my deepest gratitude to our employees worldwide for their excellent work during these challenging times brought on by the pandemic. I especially recognize the dedication of our distribution center staff, who have faced immense demands and have risen to the occasion. Their contributions to ensuring product flow to our customers have been invaluable. Our priority remains the health and wellbeing of our employees as they work to meet the needs of our customers and consumers. In summary, we are fortunate to lead an industry that is providing essential products to consumers at home, making their lives a bit easier during these times. The favorable trends we are experiencing are driving our business forward for the remainder of this year and into 2021. Our team is doing an exceptional job of navigating the pandemic and meeting the unprecedented demand surge. We are heartened by our early results for the fourth quarter. We are committed to safeguarding our employees' health and safety while meeting customers' needs and maintaining agility to adapt to the dynamic environment we operate in. I will now turn the call over to Michelle to review our financial results for the quarter.

I, too, am very pleased with how our entire organization has faced and overcome the many challenges of 2020. Our teams have our deepest appreciation for the excellent job they're doing to fulfill customer orders at a time of unprecedented demand for our products. Throughout this year, we've maintained a range of measures to ensure financial flexibility, including eliminating discretionary expenses, implementing a hiring freeze for most open positions and focusing capital spending on critical projects. We have demonstrated effective working capital management and expect to continue to increase cash flow and reduce debt. We remain disciplined, yet opportunistic in our expense and capital investment approach, focusing on maintaining a strong balance sheet to ensure we have the necessary flexibility as we navigate these uncertain times. Now let me review our third quarter 2020 results from continuing operations compared to the third quarter of 2019 and discuss our outlook. Total revenue decreased 26%. The main reason for the decline was lower sales volume in the U.S. consumer market, which occurred as a result of greater-than-expected challenges implementing our new ERP system. While unprecedented demand continued, the cutover to the new system temporarily reduced shipping capabilities at our U.S. distribution center. Additionally, constraints in the transportation industry also adversely affected shipping capabilities. The shipping hurdles related to ERP are resolved and behind us, and operations at our U.S. distribution center are operating effectively. In the international consumer and global commercial markets, lower sales were expected and driven by pandemic-related demand softness. In the Canadian consumer market, sales volumes increased as we expected. Our operating loss in the third quarter was $2.4 million compared to an operating profit of $4.4 million last year. Gross profit declined due to lower sales volume, however, gross profit margin increased by 80 basis points from customer and product mix. Selling, general and administrative expenses decreased by $300,000. The decline is primarily due to lower overall spending and the benefit from the reduction to the environmental reserve at one site. These benefits were partially offset by increases in employee-related costs due to increased incentive compensation, mostly driven by the increase in the market price of our stock, legal and other third-party fees primarily related to the irregularities in our Mexican subsidiaries and an increase in the contingent loss related to patent litigation. The 2019 third quarter includes a charge of $2.6 million to write off unrealizable assets of our Mexican subsidiaries. Turning to the balance sheet. As a result of improvement in net working capital, we have had lower average borrowings outstanding under our revolving credit facility ending the quarter with net debt of $69.6 million as compared to $78.6 million in the prior year. This, along with our average interest rate, has resulted in decreased interest expense. Use of cash before financing activities improved significantly compared to the prior year, with the use of $8.8 million for the nine months ended September 30, 2020, compared to use of $27.3 million for the nine months ended September 30, 2019. Because of the seasonal nature of our business, we typically build inventory and accounts payable during the third quarter. The net impact to cash flows to the change in inventory and accounts payable is relatively consistent year-over-year. The increase in inventory is a result of a sales shortfall for the quarter. With the expected shift of sales into the fourth quarter and strong demand expected to continue into 2021, we believe that our inventory position supports us well to meet our customers' demand. Next, let me turn to our outlook. We continue to believe we are well positioned to effectively navigate the ongoing COVID-19 environment as demand remains elevated and our cost management measures remain in place. For the second half of 2020, we expect total revenue to be in line with the second half of 2019, and operating profit is expected to increase approximately 20%. Any interruptions in shipping caused by a further challenge in the transportation industry or unexpected ERP complications, while not anticipated, could cause results to fall short of expectations. The revenue outlook includes the impact of converting some order volume to direct import by customers to help ease strains on the shipping operations. With direct import sales, we recognized lower revenue as cost savings are shared with the customer. If we imported the converted orders, revenue would be higher in the second half of 2020 by approximately $8 million, which will result in modest growth. Our goal continues to be to exceed $20 million in cash flow from financing activities for the full year. Timing of some accounts receivable collections could move into the first quarter of 2021 due to revenue expected to shift from the third quarter of 2020 to the fourth quarter. We will know more as the fourth quarter unfolds. Visibility into 2021 beyond the expectation of continuing strong demand in the first quarter is limited. So we're deferring any outlook for the full year 2021 to a later time. Also, looking ahead, Hamilton Beach Brands maintains a $115 million senior secured floating rate revolving credit facility that expires on June 30, 2021. As of the end of the quarter, we had not yet finalized the amendment to extend this facility. As a result, all amounts outstanding were classified as current liabilities at the end of the quarter. We are working very closely with our bank group and expect to finalize the amendment before the end of the month. I'll note that there were no share repurchases during the third quarter. That concludes our prepared remarks. We'll now turn the line back to the operator for Q&A.

A couple of questions. One, just on the fourth quarter revenue growth. It seems like it's implied up around 20%. Curious how much of that is recapturing some of the lost sales from the third quarter versus kind of future reorders expected from retailers given the strong demand? That's my first question.

Peter, this is Greg. It was challenging to provide an exact figure, but we are still in the process of restocking shelves with certain customers, which we aimed to achieve more in the third quarter. Some business did shift to other competitors who had their products available. However, we have substantial promotions and programs set with retailers that will begin shipping in the fourth quarter and will carry on from there. Although it's difficult to quantify precisely, a considerable portion of the third quarter will extend into the fourth quarter. We'll strive to get as much as we can out in the fourth quarter, and if sales perform as we anticipate, there could be ongoing restocking in the first quarter.

Could you discuss the recovery you're observing in the commercial markets? It's particularly interesting given the circumstances of lockdown and reopening. It appears that there is some positive movement in these markets. What insights can you share about where this activity is occurring and your expectations for this segment of your business moving forward?

Sure. The U.S. market is performing better than Europe. Europe is still facing significant fluctuations with lockdowns. Additionally, the European market is less advanced in drive-through and take-out compared to the U.S. After a complete shutdown, customers in the U.S. are now preordering to resume operations, and while some menu items are being reintroduced, there hasn’t been much new. The focus is primarily on modifying operations rather than adding new items, and businesses are investing in equipment upgrades or replacements. We are observing a stronger recovery in the U.S., a slow recovery in Europe as they reopen, and a notable recovery in China.

That's helpful. You mentioned the shipping constraints, which are separate from the ERP situation. Can you elaborate on that? You mentioned it involves inbound and outbound shipping, and it seems to be affecting various areas. How are you addressing these issues? I'm curious about your perspective on the shipping challenges as we approach the holiday season, especially with the anticipated increase in e-commerce, which has already been significant over the past few months. This surge naturally puts additional pressure on shipping channels during the holidays when volumes typically rise. I'm interested in your thoughts and your confidence level regarding getting products delivered where they need to be for the holiday season.

Peter, this is Scott. We've encountered several challenges in our supply chain, particularly with goods coming from China. We've experienced delays in shipping from several ports over there, with sailings being pushed back by a couple of weeks. However, we have a substantial amount of inbound inventory and stock in our distribution center. This time last year, most of our retailers could pick up equipment from our docks within 24 to 48 hours. Now, it takes anywhere from 2 to 10 days to get that equipment in, indicating some congestion at our docks. On the e-commerce front, I believe we're in a strong position. We've managed to address many of those constraints, and our capacity to ship a large volume of units from our distribution facility is solid, positioning us well for increased demand. We don't foresee the same difficulties in fulfilling e-commerce orders as we do with getting inventory to retailers. I anticipate that the challenges will persist for a few more weeks on both the inbound and outbound logistics, but we expect to see some relief in December.

I just have one last question. In the previous call, the ERP system was mentioned a few times. You're not the first company to deal with ERP implementations. What makes you confident that we've moved past this issue and that we won't be revisiting it in three months? Can you share anything that would reassure us about this?

Sure, Peter. During our last meeting, we were addressing some challenges and had a clear work plan in place with assignments for everyone. However, some of the required fixes took longer than we anticipated, which set us back. The positive news is that our performance in September and October has improved significantly. We're shipping consistently every day without the issues we faced in August. Now, it's mainly about catching up and managing congestion, but on a daily basis, everything is running smoothly, and the ERP system is no longer negatively affecting our operations. Thank you. It remains a challenge to manage through the COVID-19 situation. However, we have demonstrated an ability to successfully navigate the global pandemic. While we have not dealt with the pandemic before, we have managed through challenging situations in the past and emerged as a stronger company each time. This crisis has clearly demonstrated what a capable global team our company has. We remain committed to the safety and well-being of our employees and to meeting the needs of our customers and consumers as we all work together to keep our organization agile and able to respond quickly to changing needs and circumstances. In addition to benefiting from the ongoing unprecedented demand for small kitchen appliances, as people continue to shelter in place, our industry is increasingly optimistic that the new habits that have been formed will drive healthy post-pandemic demand. All this is in our sweet spot, and we are optimistic and excited about the future of our business. Despite some challenges we have faced and overcome this year, all signs point to finishing this year strong and continuing momentum into 2021. Thank you again for joining us on our call today.

This concludes today's conference call. You may now disconnect.