Griffon - Q2 2023

Transcript

Operator (participant)

Good morning, ladies and gentlemen, welcome to the Griffon Corporation Fiscal Second Quarter of 2023 earnings conference call. At this time, our lines are in listen-only mode. Following the presentation, we will conduct a Q&A session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Wednesday, 3 May 2023. I would now like to turn the conference over to Mr. Brian Harris, Chief Financial Officer. Please go ahead, sir.

Brian Harris (SVP and CFO)

Thank you, Eunice. 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 re-recording periods. These items are explained in our non-GAAP reconciliations included in our press release. I'll turn the call over to Ron.

Ronald J. Kramer (Chairman and CEO)

Thanks, Brian. Good morning, everyone, and thanks for joining us. This is the first earnings call we've hosted since we initiated our strategic alternative review process. We have a lot to discuss. Let me start by commenting on our strategic review process and its conclusion before reviewing our operating results, expectations for the year, and go forward strategy. We publicly announced the commencement of this process in May of 2022. Actually the process began even earlier in January of 2022, when we formed our Committee on Strategic Considerations and engaged our advisors, Goldman Sachs and Dechert LLP. The Committee on Strategic Considerations, which was comprised solely of independent members of our board, was given the mandate to work with our advisors to evaluate a comprehensive range of strategic alternatives to maximize shareholder value, including a possible sale, merger, divestiture or recapitalization.

Over the remainder of 2022 and into 2023, Griffon and its advisors thoroughly explored many types of strategic alternatives and engaged with a wide variety of potential counterparties with the goal of finding strategic alternatives that would provide compelling value for Griffon shareholders. After extensive review and deliberation, the Griffon board unanimously concluded that none of these alternatives which we explored appropriately valued Griffon's strong operating performance and growth prospects. As a result, the board unanimously determined that continuing to focus on executing our strategic plan is the best approach for maximizing shareholder value at this time. Our decision is a reflection of our board's confidence in Griffon's outlook and strategy. Due to the confidential nature of the process, we cannot disclose specific details regarding options explored or negotiations conducted.

What I can tell you, however, is that the duration of this process, over a year from initiation to conclusion, is an indicator of how comprehensive the process was during a period of rapidly changing economic and financing conditions. With the process now concluded, we continue to believe that there is a fundamental disconnect between our share price and the intrinsic value of our businesses. We are committed to taking a series of actions to provide additional value to our shareholders. Further, I wanna be clear that while we are no longer proactively exploring strategic alternatives, we will continue to be open to and will consider all opportunities to enhance shareholder value. Let me turn to the operating results. Griffon's performance through the first half of 2023 has exceeded our expectations.

Our results were driven by the performance of our Home and Building Products segment, HBP, which continue to see growth in commercial volume and favorable price and mix across all products and channels. Residential volume decreased year-over-year, what was better than expected. The HBP team, led by Vic Weldon, has been able to address the sectional door backlog that built up over the past 2 years. The factory is now operating with normalized backlog and lead times. This is great news as it frees up the HBP team to focus its attention on further improving productivity. It also allows the team to expand business development efforts that were previously slowed down as a result of our larger backlog and longer lead times.

The team is now intensifying their efforts to capture additional residential and commercial business by expanding marketing efforts and leveraging our leading positions in sectional and rolling steel product offerings. These efforts are complemented by a portfolio of innovative product offerings that are being positively received by customers. I wanna thank the HBP team for their extraordinary performance and ongoing commitment to building this fabulous business. Performance of the Consumer and Professional Products business continues to reflect the difficult retail market conditions in which we are operating. All CPP channels and geographies are being affected by reduced consumer demand and elevated customer inventory levels. The situation has been particularly challenging in the U.S. lawn and garden and storage and organization markets. Where we have seen customer supplier diversification drive shifts in buying decisions, which in some instances has exacerbated weakness in consumer demand.

The combination of reduced volumes and unfavorable manufacturing and overhead absorption has impacted operating leverage to the point that some of CPP's U.S. product lines have become unprofitable. To address these evolving market conditions, CPP is expanding its global sourcing strategy to include long-handled tools, material handling, and wood storage and organization product lines that are currently manufactured in the United States for sale in the United States. The CPP team will leverage its extensive global sourcing experience and capability to effectively manage this transition. By utilizing an asset light structure, CPP's U.S. operations will be better positioned to serve customers with a more flexible and cost effective global sourcing model, enabling it to manage costs and efficiently meet variable demand and to enhance future profitability.

These actions will enable CPP to continue providing high quality products, leveraging our iconic brands while strengthening our competitive positioning with industry leading distribution and service that our customers and consumers expect. In addition, these actions are a continuation of the evolution of CPP, positioning the segment to achieve targeted EBITDA margins of 15% and generating substantial additional value for our shareholders. Let's turn to guidance for the year. Our overall strong performance in the first half has exceeded our expectation. As a result, we are raising our full-year segment EBITDA guidance to at least $525 million from the previous guidance of $500 million. Earlier today, the Griffon board announced a 25% increase to our regular quarterly dividend.

This is in addition to the $2 per share special dividend and the increase in our share buyback authorization to $258 million that was approved by our board 2 weeks ago. These actions demonstrate our commitment to enhancing both immediate and long term value to our shareholders and reflect the confidence Griffon's board and management have in our strategic plan and outlook. Let me turn it over to Brian to go through some of the financials.

Brian Harris (SVP and CFO)

Thank you, Ron. I'll start by discussing our second quarter consolidated continuing basis performance. Revenue of $711 million decreased by 9%, and adjusted EBITDA before unallocated amounts of $152 million decreased by 1% both in comparison to 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 up of inventory as applicable from the current and prior periods, gross profit was $269 million in the current quarter, increasing 1% over the prior-year quarter. Gross margin increased year-over-year by 375 basis points to 37.9%.

Second quarter GAAP selling, general, and administrative expenses were $160 million compared to $150 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 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 lives intangible assets of $100 million or $74 million net of tax. The charge of results is a result of 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. A normalized effective tax rate, excluding adjusted items for the quarter, was 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 4 manufacturing facilities and 4 wood mills. We expect to complete this project by the end of calendar 2024.

In that period, we'll incur charges of $120 million to $130 million, including $50 million to $55 million of cash charges for employee retention, 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-$5 million. These charges exclude the benefit of cash proceeds from 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 31 March 2023, CPP incurred pre-tax charges of $78.3 million related to the expansion of 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 31 March 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 cost 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 15 June 2023 to shareholders of record as of May 25.

On April 20th, the Griffon board approved an increase to our share repurchase authorization of $200 million, bringing the total outstanding authorization to $258 million. I'll turn the call back over to Ron.

Ronald J. Kramer (Chairman and CEO)

Thanks, Brian. I wanna highlight that despite our businesses continuing to navigate 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 has 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 (participant)

Thank you, Mr. Kramer. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star followed by 1 on your touchtone phone. You will hear a 3 tone prompt acknowledging your request, and your questions will be pulled in the order they're received. Should you wish to decline from the polling process, please press star followed by 2. We ask analysts to limit themselves to one question and a follow up. If you are using a speakerphone, please hit the handset before pressing any keys. One moment please for your first question. Your first question comes from Bob Labick with CJS Securities. Please go ahead.

Brian Harris (SVP and CFO)

Good morning, it's nice to talk to you again.

Ronald J. Kramer (Chairman and CEO)

Good morning, Bob.

Brian Harris (SVP and CFO)

Congratulations on continued strong performance. Obviously, so many questions. I'll follow the instructions and ask to, keep it brief and get back in queue. Maybe starting with HBP, obviously, the performance has just been off the charts and hard to model in a good way. Clearly, margins have improved materially from, mix pricing and operating efficiencies that you've garnered over the last year plus. Can you give us a sense of maybe what's the new normal range for Doors operating margins looking out, and how, and, how we can think about has there been like a, overbuild period where we are in the demand cycle, and what are normalized margins over the next few years for this business?

Ronald J. Kramer (Chairman and CEO)

Let me start by saying that, the company, it gets lost in moments in time. You have to go back and recognize that we have been on a 5-year journey of building the Clopay business. We bought Cornell Cookson going on 5 years ago. We had 3 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, 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 a 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, will continue to grow. 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. We have a business that finished last year with $412 million of EBITDA, will be better than that this year. That's why we have confidence in raising our guidance. We believe 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, you wanna add to that?

Brian Harris (SVP and CFO)

I think you summarized it pretty well. Unless, Bob, you have an additional question to it, I don't have anything.

Bob Labick (President and Director of Research)

Oh, no. That's I think that's super helpful there. Maybe just, 'cause I do appreciate the, taking a step back, and obviously we've been watching this journey since Cornell Cookson and the integration and the expansion and everything. Maybe give us a sense of the commercial market opportunity and where you've, been growing and where you're targeting additional growth in commercial now that you're kind of fully integrated and ready to go after it.

Brian Harris (SVP and CFO)

Sure. I'll start. The commercial market has been strong. We 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 historical or 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. Now that our backlog and our lead times are normalized, we are gonna be back out there and getting after that business.

Of course, things like warehouse space, institutional, type operations is where we see most of our business.

Operator (participant)

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

Tim Wojs (Senior Research Analyst)

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

Ronald J. Kramer (Chairman and CEO)

Hi, Tim.

Brian Harris (SVP and CFO)

Hello.

Tim Wojs (Senior Research Analyst)

Hello. maybe just the first one, on maybe CPP. Is there a way just to maybe level set us, in terms of kinda where that business, after all the changes kinda lands from a revenue perspective on a normalized basis?

Brian Harris (SVP and CFO)

Sure. As we go through this process and come out the other side at the end of 2024, we see this as a $1 billion-plus size revenue business that will be generating 15% level margins.

Tim Wojs (Senior Research Analyst)

Okay, good. Then maybe just on the cash flow, kind of a two-parter. I guess first, like, cash flow is 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 in a pretty meaningfully higher relative to net income? 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 (SVP and 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. It can be meaningfully better than net income, as you pointed out. We stick with our stated better than net income, which falls under that category.

Let me just add, start with our balance sheet. We don't have a debt maturity until 2028, and we have substantial free cash flow. We've authorized $258 million. Stay tuned.

Operator (participant)

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

Noah Merkousko (Senior Research Associate)

Good morning, and thanks for taking my questions.

Brian Harris (SVP and CFO)

Morning.

Noah Merkousko (Senior Research Associate)

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. I guess, how do you get confidence in the demand there for commercial and res R&R?

Brian Harris (SVP and 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. Actually, the volume has been a little better than we originally expected, and leads to us raising our guidance. On the commercial side, we continue to see strong volume. Our products are doing well, and I reference back to us going after commercial sectional business, leveraging our legacy Cornell Cookson relationships.

Ronald J. Kramer (Chairman and CEO)

The other point I'll make is and our pricing has, and we expect it to continue to hold.

Noah Merkousko (Senior Research Associate)

Got it. That's really helpful. Then maybe 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 2024. At what point.

Ronald J. Kramer (Chairman and CEO)

25.

Noah Merkousko (Senior Research Associate)

Okay, 25. At what point would you expect,this strategy to start bearing fruit or, start becoming accretive to segment margins?

Brian Harris (SVP and CFO)

2024 will remain a transitional period as we move over these particular product lines to a sourcing model, and those benefits will come through in 2025. We expect it to take till roughly the end of calendar 2024.

Operator (participant)

Thank you. Ladies and gentlemen, as a reminder, if you have any questions, please press star 1. Your next question comes from Sam Darkatsh with Raymond James. Please go ahead.

Sam Darkatsh (Managing Director)

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

Ronald J. Kramer (Chairman and CEO)

Doing well. How are you, Sam?

Sam Darkatsh (Managing Director)

I'm well as well, and it's good to hear your voices, certainly on a formal basis.

Ronald J. Kramer (Chairman and CEO)

You too.

Sam Darkatsh (Managing Director)

A couple questions, and I actually have three or four. Maybe I'll get back into the queue if possible. 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 at work while the stock is at current levels?

Ronald J. Kramer (Chairman and CEO)

We don't think it will take years, and we'll consider any and all possibilities, but we're 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 (Managing Director)

Gotcha. The retention payouts, Brian, do they continue, or how are they gonna be accounted for now that the strategic review process has concluded, at least for the time being?

Brian Harris (SVP and CFO)

We'll continue to call those amounts out, as they are. Though they are over several years, they are a specific event. Those payments will continue, each third quarter for this year, next year, and the year after.

Operator (participant)

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

Ronald J. Kramer (Chairman and CEO)

I think Sam has some more questions.

Sam Darkatsh (Managing Director)

Hello? Am I on?

Hello? Am I on?

Ronald J. Kramer (Chairman and CEO)

Sam, you're on.

Sam Darkatsh (Managing Director)

Can you hear me okay?

Ronald J. Kramer (Chairman and CEO)

Yes.

Sam Darkatsh (Managing Director)

Okay, terrific. Sorry about that. my last question, again, getting back to the CPP sourcing, which is fascinating. Where specifically are you contemplating moving the sourcing from a geographic standpoint? Is that gonna be a 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.

Ronald J. Kramer (Chairman and CEO)

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.

I view what we're doing to our CPP business is a 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't be supported other than being on an outsourced global sourcing model.

Brian Harris (SVP and CFO)

I would 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. It's not gonna be sole sourced to one person or one entity. In fact, using entities over against themselves in further periods will give us even more advantage.

Sam Darkatsh (Managing Director)

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-handled tools, whereby you're able to have high fill rates during the heavy selling season. How has that impacted? 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 and 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 (SVP and CFO)

Sure. you touched upon part of it. We'll be sourcing from possibly, closer areas such as Central America. Further, we'll 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 (Managing Director)

Gotcha. If I'm still on.

Brian Harris (SVP and CFO)

You're on.

Sam Darkatsh (Managing Director)

Okay. Terrific. They didn't cut us off yet. All right.

Brian Harris (SVP and CFO)

No, we're not. We've been silent for a while. Keep going.

Sam Darkatsh (Managing Director)

It's 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 (SVP and CFO)

It'll 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.

Ronald J. 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 2028. 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 gonna be acquiring as much of us as we can with free cash flow for the foreseeable future.

Sam Darkatsh (Managing Director)

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

Ronald J. Kramer (Chairman and CEO)

Thank you.

Brian Harris (SVP and CFO)

Thank you.

Operator (participant)

Thank you, Sam. There are no further questions.

Ronald J. Kramer (Chairman and CEO)

Any other questions? Okay. Well, thank you all. Look forward to speaking to you after our next quarter in early August.

Operator (participant)

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.