Huttig Building Products, Inc. (NASDAQ:HBP) Q4 2018 Earnings Conference Call March 5, 2019 11:00 AM ET
Jon Vrabely - President, Chief Executive Officer and Director
Philip Keipp - Chief Financial Officer and Executive Vice President
Bob Furio - Executive Vice President and Chief Operating Officer
Conference Call Participants
Robert Maltbie - Singular Research.
Good morning and welcome to the Huttig Building Products' Fourth Quarter 2018 Earnings Call. Participants will be in a listen-only mode until the end of the call, when the company will have a question and answer session. [Operator instructions]
I will now like to turn the call over to Philip Keipp, Vice President; Chief Financial Officer. Please go ahead.
Thank you and welcome to Huttig's fourth quarter 2018 earnings call. With me this morning is Jon Vrabely, President and Chief Executive Officer and Bob Furio; Executive Vice President and Chief Operating Officer. During the call today we will discuss our fourth quarter and full year 2018 operating and financial results and provide commentary on our progress and executing our strategic growth initiatives. Following the prepared remarks, the operator will open up the line for questions.
Let me take a moment to remind you that today's discussion reflects management's views as of today, and may include forward looking statements. Actual results could differ materially from those currently anticipated and Huttig disclaims any obligation to update information discussed on this call as a result of developments that occur afterwards. Also, to the extent you are listening to this call on replay information could have already changed additional information about factors that could potentially impact the financial results is included in the earnings release issued yesterday and in our filings with the SEC.
During this call certain non-GAAP financial measures will be discussed. A description of any non-GAAP adjustments and reconciliation to the most comparable GAAP measures can be found any earnings release issued yesterday and on the company's website at www.huttig.com. Today's call is being webcast live and is being recorded. If you ask a question, it will be included in our live transmission and in the future use of the recording; you can replay the call on the investor relations page of the website under financials.
And now it's my pleasure to turn the call over to Bob.
Thank you, Phil. Good morning. And thank you for joining our fourth quarter and year end 2018 earnings call. I will provide an update on our strategic growth initiatives and Phil will discuss our financial performance for the quarter and fiscal year. Over the past two years, the entire organization has been immersed in implementing and executing our strategic organic growth plan to diversify our business and position the company for many years of above market growth.
We've made significant investments in people, capital equipment and facilities in working capital to expand our value add door fabrication services and our product line offerings. The investments we have made are creating the opportunity to substantially grow market share and the core segments we have historically served, as well as with customer segments that have not historically been core to our business.
Although, we are still in the very early stages of implementing and executing a transformative growth strategy. The investments we've made in 2017 have allowed us to continue to achieve meaningful growth in 2018. From a market perspective on a year-over-year basis, single family housing starts declined 8.5% and multifamily starts declining 2.6% in the fourth quarter of 2018 with moderate growth in the repair remodel market.
Based on the market segments that we serve, we estimate our market declined approximately 3.8% for the quarter by comparison; we achieved total sales growth of approximately $17 million or 9.5% in the fourth quarter. For the year, single family housing starts increased 2.8% and multi-family starts increased 5.6% with modern growth in the repair and remodel market.
Based on the market segments we serve, we estimate our market increased approximately 3.6% in 2018. By comparison, we achieve total sales growth of approximately $86 million, or 11.5% in 2018. We believe this clearly demonstrates that our growth strategy is working.
Growth from the investments we made in our strategic initiatives accounted for approximately 70% of our total revenue growth in 2018. We estimate that the total revenue growth to our core customers was approximately 7%, while growth to our non-core customers was approximately 36%. Approximately 40% of our 2018 revenue growth was derived from non-core customers.
This highlights our continued expansion into non-traditional customer segments, while also illustrating the remaining growth opportunities with our core customer base. The investments we've made in our pre-finished capabilities have given us the capacity to continue to grow our revenues in this value add service. As a result of these investments, which are made in connection with our strategic growth initiatives on a year-to-date basis, we grew up prefinished revenue by approximately 25%.
As we've stated previously prior to launching the national expansion initiative in early 2017. Huttig sold all of the products today are part of the Huttig-Grip product line. However, they were sold on a limited geographical basis and in many cases did not cover the full breadth of the category. To put our Huttig-Grip growth into perspective, our revenue growth of Huttig-Grip products was 73% in 2018 as compared to 2017 and grew 53% in the fourth quarter, as compared from the fourth quarter a year ago.
On a year-to-date basis, 2018 Huttig-Grip revenue was $52 million higher than prior year. As discussed on prior calls, due to various factors. We were behind on the sales execution phase of our growth strategy. This had a negative impact on our operating results over the last two years. Today, we believe these hurdles have now been cleared as demonstrated by our continued above market sales growth. We now have the full breadth of products to support our customers; needs.
Over the course of the second half of 2017 and through the first half of 2018, we built the necessary array of product items to successfully compete in the marketplace. The feedback, we have received thus far has been overwhelmingly positive and we are gaining traction. We believe the opportunity is significant for a short and long-term.
As we turn to 2019, our operating and financial priorities are. One, to continue to achieve above market sales growth even with the bars raised on a year-over-year basis based on 2017 and 2018 sales growth. Of note, we have recently realigned our sales management structure which we expect will further drive our strategy. Two, achieve margin improvement through a more profitable sales mix, including a focus on increasing warehouse sales. Three, lever our cost structure to bring our operating expense ratio closer to historical pre initiative levels. We configured a deep dive into our expense structure and put triggers in place to better manage our variable costs.
Four, manage our working capital and continue to pay down debt. We also continue to right size and rebalance our initial inventory buys, bringing levels more in-line with sales demand. Finally, we have restructured all of our field incentive compensation programs to bring full alignment throughout the organization with our key business priorities. We believe that this will help drive the necessary behavior to help us execute on our priorities as we move through 2019.
Now, I'd like to turn the call over to Phil to discuss our financial performance.
Thank you, Bob. Fourth quarter 2018 net sales were $196.2 million, which was $17 million, or 9.5% higher than the fourth quarter 2017. For the year 2018, net sales were $839.6 million which was $86.4 million or 11.5% higher than 2017. As Bob previously discussed, we believe these increases are significantly above market. The revenue increase in the quarter and on a year-to-date basis was primarily attributable to a general full year increase in residential construction activity, as well as organic growth derived from the execution of our growth initiatives. We grew the building products and millwork categories in the fourth quarter and all product categories grew end of fiscal year 2018 as compared to 2017.
Gross margins were 19.4% of net sales during the fourth quarter 2018 compared to 20.5% during the prior year period. For the year 2018, gross margins for 19.8% of sales compared to 20.7% a year ago. The 110 basis point reduction in gross margin percent during the quarter and 90 basis point reduction year-to-date were largely driven by an increase in direct sales volumes, as well as proportionally increases and building product sales as compared to growth of higher margin product categories.
Our operating expenses were $44.2 million during the quarter, fourth quarter of 2018 compared to $42.2 million during the fourth quarter of 2017. Non-personnel expenses increased approximately $1.7 million, primarily as a result of higher fuel prices, increased contract hauling costs and higher facility costs. As a percentage of sales, operating expenses decreased to 22.5% in the fourth quarter of 2018 compared to 23.7% in the fourth quarter of 2017.
Operating expenses increased $11.8 million or 7.6% to $167.5 million or 19.9% of net sales for the full year 2018 compared to $155.7 million, or 20.7% of net sales in 2017. The increase in operating expenses was partially attributable to an increase in personnel costs. Personnel costs increased approximately $4.8 million primarily as a result of wage increases and increased variable compensation. Non-personnel expenses increased approximately $7 million, primarily as a result of higher fuel prices, increased contract hauling costs, higher facility costs and expenses associated with prior litigation and settlement. Operating expenses include charges of $3.5 million and $3.1 million in 2018 and 2017 respectively related to settled litigation. Excluding these expenses, operating expenses would have been approximately 19.5% and 20.3% of sales for the year-ended December 31, 2018 and 2017 respectively.
Net loss from continuing operations was $6.9 million during the fourth quarter of 2018, as compared to $8.9 million in the fourth quarter 2017. Adjusted EBITDA was a negative $4.1 million during the fourth quarter of 2018 as compared to negative $3.1 million during the fourth quarter 2017. For the year, we generated net loss from continuing operations of $6 million and $6.2 million in 2018 and 2017 respectively. Full year adjusted EBITDA was $10.2 million in both 2018 and 2017.
We recognize a net loss from discontinued operations of $0.4 million in the fourth quarter of 2018 as compared to $0.9 million in the same period a year ago. The losses related to a change in estimate associated with the remediation of a formerly owned property at Montana.
Turning to the balance sheet, we ended 2018 with total debt of $138.9 million compared to $103 million at the end of 2017. We generated approximately $30 million in cash from operations in the fourth quarter 2018 as compared to $1 million in the prior year period. We pay down debt by $30.1 million in the fourth quarter of 2018 bringing the outstanding balance under our revolving credit facility to $132.3 million as compared to $99.2 million a year ago.
The increase in bank debt is primarily due to a $22.1 million increase in inventories principally related to our Huttig-Grip initiative. We remain sharply focused on right sizing our inventories as the initial inventory build of Huttig-Grip products, coupled with the slower than expected sales execution rate has resulted in lower churns as compared to our historical performance. These products also typically require a longer lead time and thus our on hand quantities are generally higher than core product requirements in order to support anticipated demand.
Now I will turn the call over to Jon for closing comments.
Thank you, Phil. As we enter 2019, we are two years into the implementation of our growth and diversification strategic plan. Few companies in our history, if any, have ever attempted to develop, implement, fund and execute its strategic plan of this scope and magnitude.
From inception, I understood that we would face challenges as we developed and implemented this strategy. During the initial planning and analysis phase and throughout the period of time leading up to the implementation and execution of the plan. I communicated to all of our associates that this would be the most difficult endeavor any of us would ever embarked on in our careers.
I explained that we were embarking on a transformative journey that was a marathon not a sprint, and it would take years not months to complete, but that once we built the foundation, have all of the components of the plan in place, and successfully transformed Huttig into a more diversified company that possess significant growth opportunities for many years into the future that this endeavor would also be the most rewarding for our careers.
With hindsight, the past two years have been everything I thought they would be and more. Even though we are still in the relatively early stages of executing our plan, our revenue growth in 2018 clearly demonstrates that we have successfully built the foundation to transform Huttig into a more diversified company that possesses the potential to achieve above market growth for many years into the future.
We believe we have just truly scratched the surface in terms of realizing the potential of the opportunity we created. While we are pleased that our customers both core and historical non-core have responded so positively to our expanded value add services and products and have rewarded us with meaningful share gains in such a short period of time, we have yet to successfully leverage our sales growth into increased profitability.
In addition, while we made solid progress throughout the year, we were not as successful in 2018 in rationalizing our inventory levels, which resulted in higher working capital and debt at the end of the year and planned. As we head into 2019, all of the required investments to support the strategy are in place and for the first time in more than two years, our entire management team can truly focus on what we do best as financial managers and operators.
We are confident that we can continue to grow and an accelerated above market rate while simultaneously leveraging the costs and inventory that was layered into the organization during the initial implementation of the strategy.
To that end, we continue to focus on executing the sales growth plan. We are also focused on improving our gross profit and operating expense ratios. We completed actions in early January to adjust our expense structure and believe these actions position us to achieve operating expense ratios in 2019 that are closer to those in the years immediately preceding the implementation of our strategic growth plan.
Lastly, we continue to focus on rebalancing and repositioning our inventory to reduce our working capital. Work towards increasing our cash generated from operations and reduce our debt and increase our liquidity throughout the year.
Operator. We will now take questions.
First question comes from the line of Robert Maltbie with Singular Research. Your line is open.
Congratulations on a heck of a year in a tougher environment, gentlemen. Question, just a couple. Regarding the difference between a non-core customer and a core customer and a little bit about the difference in the gross margins that generated from Huttig-Grip last year for 2018 versus non Huttig-Grip.
Okay. This is Jon and first, Robert, thank you for joining the call and thanks for the questions. I will take the first part of the question kind of core versus non-core customers and really it's internal description of the customer base and customer segments that Huttig historically service. So with the implementation of our strategic growth plan, part of that plan was to not only put the organization in a position to grow above the market for many years into the future, but also to assist us and really diversifying our business. So that we were not as reliant going forward as we have been in the past on the potential volatility of the single family housing market, new construction housing market.
So with the investments we've made in our added, value add services around prefinished, as well as the product line expansions that we have made. It opened up the opportunity for us to pursue customer segments that Huttig has historically not service. So the breakdown in core versus non-core customer segments that we refer to primarily relates to the customers that were very core to our business prior to January of 2017.
Customers that we refer to as historical non-core customers are really the customers that operate in market segments that historically Huttig is not focused on either because we didn't have the service capabilities or we did not have the full breadth of the products to really effectively pursue with those customer segments.
And this is Bob. And just to elaborate a little bit on the margin differential, we have not realized the potential of margin on the Huttig-Grip brand, the product categories. Predominantly because what drives the higher margin and what completes the entire offering of our brand in the packaged nails and screw sets. And that's the - that was one of the parts of the program that was lacking that came into 2018, which gave us the ability to really drive in the second half of 2018 here into 2019 or being able to go do customer conversions. So those packaged nails and screws drive substantially higher margins, which is obviously an effect on the overall category.
So, yes, Robert. Getting back to the point and by the way, this is Phil. Back to the point, we made in the opening, our margins were really kind of impact this year by product mix and by the mix of sales volume out of warehouse versus ship direct, which is one of our priorities that Bob mentioned on the call as we look towards 2019 to try to - to try to address the - an increase of warehouse sales and objective of ours.
Thank you. Then a brief follow-up to that, Phil. For 2019, do you have a target working capital amount in a target debt amount that you're expected?
Yes. So Robert, we do --we have some internal targets that we have in slides. We had some targets that we put in place for the end of 2018. We made some progress in 2018 toward achieving those targets, still a high focus area for us. And I think that the cash flow that we experienced in the fourth quarter is indicative of that, generating the $30 million in cash and being able to pay down our debt. So as we move into 2019, we're going to continue to focus on the working capital aspects, not just inventory, but all aspects of working capital.
Our next question comes from the line of Richard Lubman. Your line is open.
Good morning, gentlemen. I have a few questions. I follow this company for many, many years. I'm at a point now where I really don't understand what's going on. And the reason why I think is because the Huttig-Grip business is a different business than the millwork business. Is it possible to do reporting by segment rather than by putting it all together in one thing you have different - there's different - it's different inventories, it's different timing. When you're going to be doing? Would you see that that as necessary?
Richard. This is Jon Vrabely. All of the products today that we sell in the Huttig-Grip category, Huttig-Grip historically sold every one of those products and the sales of those products have historically rolled up into our building products reporting structure from a segment perspective. So we see no need to change that segment reporting structure. It was really an initiative to expand the products that we had already sold previously for many, many years. The Huttig Group private label brand has been around for a multitude of years, decades, not years.
But so the all of the products that today are under the Huttig umbrella are really products that we have historically sold. We've just really expanded both the product lines and the geographical reach of those products. So we do not see a need for them to impact our financial reporting from a segmentation perspective.
Got it but I don't understand it, but whatever. Now your inventories were down $19 million in the quarter but they're still higher than last year. By implication, did you reduce prices to clear excess inventories? And which inventories were cleared out? And will it have an impact on your future sales?
So we have not reduced pricing. We do not believe that any of the inventories that we added to support any of the expansion initiative is certainly not saleable or that it is the wrong inventory to be able to conduct business. The issue really is that because we added so many products to so many new products to new locations. That we had to have the entire breadth of the category in place to be able to service the new business that we are now actually achieving. If we had not had the full breadth of the categories in place, we truly would not have been a potential viable option for customers that had not historically looked to Huttig to purchase those products.
So we are in the process now of truly rebalancing and repositioning the initial inventory build to support all of the growth initiatives that we embarked on in 2017. We do believe that there's still room to bring our total inventory values down, but it is really an issue of rebalancing those inventories to ensure that we have all of the right products in the right locations based on the sales opportunities that exist in those specific trading areas.
Okay, is the excess inventory from last year in Huttig-Grip or is it in millwork and building products?
Yes, so we have a very, I would tell you that we have a very disciplined approach towards measuring what we call excess and obsolete inventory. And we have excess inventory virtually across every product category that we are in. And that is not a new scenario to our organization. As a result of this initiative or any of these initiatives. So to answer your question, it's both, I would tell you that the biggest area today that we are working on obviously is the rebalancing of the new inventory that we have added two new locations to support primarily the Huttig-Grip initiative.
But we have also added significant inventory to support our prefinished expansion initiative both in Florida as well as throughout New England to ensure that we can also service the new customer segments as well as historical customer segments that we are looking to grow those value added services,
Now you trunked back a number of your locations during from 2008 on. It was necessary, obviously, but I see that you're having increased in expenses for transportation and such. Is that what's causing the increased costs? I mean you had - I'm getting that --what do - do you see a path forward where you'll actually be able to pay enough for the products and services you provide? Or is it being eaten up in expense? What? That's what I'm missing here. I understand you have little bit time and it's tough. But yes, you know.
So, Richard Yes. So, again embarking on an initiative with this scope and size, one of the things that, we've learned is that from an inventory perspective, inventory management perspective, is the rebalancing of the inventories that Jon alluded to. Part of that is to we're getting inventories in the right locations, the right inventories and the right locations to move the inventory. So that has resulted in a fair amount of efficiencies, if you will, and our brand structure. In addition to that the contract hauling costs as well, for moving that product around, we have made a lot of progress in that regard in terms of getting it to the right place, getting the inventories rebalanced. But there's still work to do. And we are and have been focused on that aspect of our business.
And there's one other aspect as well. And that is really as it relates to labor. I mean, with the economy, the way that it's been, there's been a fair amount. I think most businesses realize the fair amount of turnover and trying to get that skilled labor that skilled help, especially when you have that that turnover takes a little bit of time to develop that skill set. So there are significant efficiencies that are a result of that as well. So it's a reality of the landscape today and one that we've been working through and continue to work through and again, that's why we focused on value add and higher margin opportunity programs that are going to be there for the long term for us.
Sure. Well, it cuts both ways because the builders have problems getting people too. So you are prehung products should be more in demand. I understand where you're coming from. And I see there's a possibility that you could do well. So but that having slower inventory return items in amongst inventory, which I think is the Huttig-Grip product makes it harder to see. And I would consider, I mean, separate the business lines for reporting purposes. I'm sorry; I don't get what you're trying to do. You know, I mean, it all makes sense in terms of business going to a higher margin product makes sense; having prehung doors in the tough environment makes sense, but it doesn't show in the profits.
Yes. Richard. So there are a couple things. First of all, as the market has grown back from the depths of 2008 and 2009, to be frank your assumption of pro-umber dealers, having a higher demand for prehung door products is actually incorrect because as the market has come back, more and more pro-lumber dealers have actually gotten back into that business of prehanging the high velocity vanilla items as the market has returned, and as their financial position has improved over the years.
Part of the reason why and a large reason why we have made the investment in increasing and expanding our prefinished capabilities is due to the fact that we are the largest fabricator of interior and exterior doors to the pro-channel in the country. And that was an additional value and service that we could provide at higher margins to potentially offset a sales mix shift that would occur at pro-lumber dealers not increase their demand from wholesalers in prehung door units, but actually decreased their demand.
So that was one aspect. The other aspect of the confusion, I would say to be frank, I don't - I'm still not quite connecting the dots on your confusion around our strategy in the sense that the construction fastener market and the building product markets that we are expanding, all of these products across our entire geographical footprint offers the opportunity from a market perspective literally in the billions of dollars that Huttig has played historically in a very small aspect of. So the scope and magnitude of the change process that we have embarked on two years ago is larger than any change process from a strategic perspective that I'm certainly aware of that any company our industry has going through from an organic growth perspective. I've been with Huttig nearly 20 years and had been in the industry for that entire period of time.
So what we have embarked, what we have embarked on is truly a transformational process to expand products that we have this have sold historically, but on a very limited basis to expand those products and expand those sales across all of our locations, opening up an opportunity to pursue a multi-billion dollar market opportunity on an annual basis with customers that have been core to Huttig, but we have never capture that market opportunity nationally, as well as a variety of customer segments that Huttig has not sold to historically.
So the products that we are selling today on a national level are no different than the products that we have sold historically. It is truly just a very large organic growth strategy that has required the investment in both working capital and expense. Now that we are truly two years into the process, and we have virtually a year under our belt and pursuing in implementing the sales execution part of the strategic plan.
We are in a much better position today to truly assess all of the expenses from an operating perspective that we've had to invest to ensure that we did not fail in the early stages of the execution process by having customers either historically core or non-core give us the opportunity to earned their business. And then not being in a position to services.
We've had a very short period of time throughout 2018 to truly assess that based on the $86 million, or 11.5% growth that we've achieved this year. We've had a very short period of time in the big picture of things to truly assess what are the appropriate levels of operating expenses that we need to service the business that we have gained, as well as continue to garnish new business in the future. And from an OpEx perspective, we believe we are in a much better position today to assess that than we weren't even a year ago.
And we have taken action to adjust that cost structure, ensuring that not only can we continue to execute the business that we have been awarded, but also to continue to grow in a manner that does not jeopardize the business that we have gained to this point, or jeopardizes the continued very large future growth opportunities that are in front of us now that we have put all of the places or all of the pieces of the puzzle in place to truly pursue and execute the growth strategy. So hopefully that has helped and cleared it up a little bit.
Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to Jon Vrabely for closing remarks.
Thank you. In the face of the challenges and stress that this endeavor has placed on the organization, it is exciting to see the type of growth we've achieved in 2018. While we still have a lot of work to do, I am proud of what we have achieved during the most difficult period of change that any of us have ever faced in our career. I would like to thank all of the Huttig associates for their dedication and hard work that they've put for on behalf of all of our stakeholders. I also want to thank our customers and supply partners for the trust they place in us each and every day to care for their business.
Finally, I thank you for your interest in ownership in our company and for your participation in our call today. We look forward to speaking to you again in April when we report our first quarter results.
Ladies and gentlemen, thank you for participating in today's call. That concludes the call. You may now disconnect. Everyone have a wonderful day.