Hamilton Beach Brands Holding Company (HBB) Q3 2018 Earnings Report, Transcript and Summary

Good afternoon. My name is Tiffany, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hamilton Beach Brands Holding Company Third Quarter 2018 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the conference over to Lou Anne Nabhan, Investor Relations Consultant for Hamilton Beach Brands Holding Company.

Thank you, Tiffany, and good morning, everyone. Welcome to the third quarter 2018 earnings conference call and webcast for Hamilton Beach Brands Holding Company. Greg Trepp, President and Chief Executive Officer; and Jim Taylor, Vice President, Chief Financial Officer and Treasurer will discuss the Company's third quarter results. Scott Tidey, Senior Vice President, North America Sales and Marketing for Hamilton Beach Brands will participate in the Q&A. Also with us today is Michelle Mosier who as recently announced, will be succeeding Jim following his retirement at the end of this year. Yesterday, after the market closed, the Company issued an earnings release announcing third quarter 2018 results and filed a 10-Q with the SEC. Both documents can be found on the Company's website at www.hamiltonbeachbrands.com. A replay of today's call will be posted on the website this afternoon and when available, a transcript will be posted. Today's presentation 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 was included in our earnings release and 10-Q. The Company disclaims any obligations to update these forward-looking statements, which may not be updated until our next quarterly conference call, if at all. Also, certain amounts discussed during today's call are considered non-GAAP. The non-GAAP reconciliations of these amounts are included in our earnings release. And now, I'll turn the call over to Greg.

Thank you, Lou Anne. Good morning, everyone, and thanks for joining the call. My remarks will cover the third quarter performance of our two business segments, Hamilton Beach Brands and Kitchen Collection. At Hamilton Beach Brands, we had a strong third quarter, continued progress with our strategic initiatives, drove a 12.3% increase in revenues, $19 million over last year. We were able to extend the revenue growth momentum that we reported in the first and second quarters of this year. The revenue growth reflected higher sales volumes in all of our businesses. Our U.S. Consumer business experienced strongest growth across a broad base of retailers. Our international businesses experienced growth and Latin America and Mexico, our business was up in the quarter and growth in our global commercial business was attributable to increased sales of food service products and hotel amenities. Operating profit in the Hamilton Beach Brands increased $4.4 million over the last year as a result of higher gross profits and lower operating expenses. The decrease in operating expenses is mainly due to the absence this year of $2.5 million in one-time costs related to our spin-off from NACCO Industries and last year’s third quarter. This amount was partially offset by a $1.4 million increase in professional and outside service fees mostly for patent litigation expenses. Net income doubled from last year from $10.2 million and reflects our increased operating profit in the lower federal corporate tax rate. We are excited to be in a full holiday selling season and typically our biggest quarter of the year. We have strong promotions and product placements in place. And we’ve introduced some number of new products this year in a wide range of categories supporting Hamilton Brands and our portfolio. One new product line I’d like to elaborate on was our FlexBrew coffeemaker line which is performing very well. The FlexBrew coffeemaker allows consumers the flexibility to brew a single cup, using ground coffee or K-Cup Sell Packs and some machines allow you to also brew a full time. We continue to experience strong sales success for our FlexBrew line and have a strong presence across retailers. For this holiday selling season, we increased support of this product line with the new advertising campaign as well as the addition of a new FlexBrew product including a Wi-Fi connected version. Compared with a strong fourth quarter last year, we expect revenues to increase modestly in this year’s fourth quarter. Operating profit is expected to decrease year-over-year primarily as a result of our investments in consumer advertising during the holiday selling season, higher transportation costs and increased employee-related expenses. . As you know, our business is best viewed in the first half, second half of the year basis. Last year, we had a carryover into the fourth quarter resulting from timing in shipments from the third quarter which slightly suppressed the third quarter and inflated the fourth quarter of 2017. This year, we had a strong third quarter both because we are doing well and because we had a slightly soft comp period. So, while our outlook for the fourth quarter is modest revenue growth, we continue to expect our revenue growth in the total second half of this year to increase moderately over the last year. But this year as a whole, Hamilton Beach Brands is on track to introduce over 85 new product platforms, supporting all of our strategic initiatives. Several highlights include the introduction of our new Wolf Gourmet coffeemaker, a new Chi, touch screen iron and our new commercial auto juice extractor. We have new products coming to market in categories such as stand mixers, hand mixers, blenders, multi-cutters, bread makers, coffeemakers, pressure cookers and pasta makers among many others. Some of these items will impact 2018 and all of them should benefit us in 2019 and beyond. Our dedicated and enthusiastic teams develop our consumer-driven new products using our good thinking innovation processes. The team has done a really great job this year and I am proud of their success and hard work. Next year we will schedule to introduce a similarly strong line-up of new products. We’ll continue to expand our participation in the – only the best markets. In this premium segment, we are investing in new products that are sold under the Weston, Hamilton Beach Professional Chi and Wolf Gourmet brand names. Our Chi line of products continues to expand distribution and sell well. Weston, Hamilton Beach Professional and Wolf Gourmet are all growing and should continue to grow in 2019. Under the Wolf Gourmet brand, in addition to the new deluxe automatic drip coffeemaker, this year, we introduced a multi-function cooker, a precision griddle which has been very well received in the high-end markets. In our global commercial business, we are increasing our presence through enhanced product lines with chains and distributors serving a global food service, and up the Italy markets. Our reputation for performance, reliability and differentiated products is driving growth. Examples of our newer commercial products with increased penetration in regional and global chains are auto, juice extractor in our new Quantum high performance commercial blender. We’ve also introduced a new line of commercial chamber vacuum sealers that has strong growth potential. Leveraging our sourcing, marketing and e-commerce fronts to drive category and channel expansion, new products include several items for longer care coffee serving products and knife sharpeners among many others. E-commerce continues to be a key driver of Hamilton Beach Brands success. E-commerce rewards brands, innovation and product quality above and beyond traditional brick and mortar retailers. E-commerce also provides the opportunity to launch new online all new products. We continue to leverage our strength in these areas and have built leading processes and capabilities globally. Our products continue to earn strong [Inaudible] We also continue to pursue the opportunity for international growth, particularly in the emerging Asia and Latin America markets, while also continuing to expand in Canada and Mexico. Hamilton Beach Brands has great strength in our comprehensive coverage of the marketplace including well-known brands, price points from value to luxury and our participation in over 50 categories. We believe that this is a significant competitive advantage that will help drive our ability to reach our goal of $750 million to $1 billion in revenues. As we move towards the target sales level, operating margins are expected to increase over time as a result of leveraging fixed cost. Next, let me discuss our Kitchen Collection business. The ongoing trend of declining customer traffic at mall stores continue to put downward pressure on revenues and results. Our team is doing a very good job delivering strong gross margins, controlling inventory levels and reducing SG&A expenses. Kitchen Collection currently operates 197 stores. Kitchen Collection continues to focus on its strategy of optimizing a store portfolio by exiting unprofitable stores while working aggressively to maintain gross margins, reduce operating expenses and manage working capital at its remaining stores. We expect to close six additional stores by January 1, 2019 and 25 to 35 more stores by the end of 2019 through natural lease expirations. By the end of this year, we expect that about two-thirds of our stores will have a lease term of approximately one year or less. After the expected closures and anticipated lease renewals in 2019, we expect Kitchen Collection will have over 80% of its stores with a lease term of one year or less. As we stated previously, our plan is to cost-effectively optimize our store portfolio to what we expect will be a smaller core group of 100 to 150 profitable stores in saleable outlet mall locations. Kitchen Collection is working hard to provide consumers with highly desirable products at affordable prices. For the fourth quarter, we’ve built compelling products and promotional offerings for the holiday selling season that is designed to create consumer excitement. However, due to the highly unpredictable nature of foot traffic in related spending, we are cautious in our outlook except to say that revenues are expected to be lower in the fourth quarter compared with last year while operating results are expected to be comparable. With the overview of our two segments, I would like to turn the call over to Jim for more details about our third quarter results. But first let me make a few additional comments. As you all know, Jim is going to retire at the end of this year after 35 years of outstanding service. Jim has played an integral role in driving our growth and success over the many years he has been with us. His financial stewardship, and discipline, ethical compass and leadership have been invaluable across our global enterprise. This past year, Jim played a very key role in our smooth transition to becoming independent public company. I want to thank Jim for his substantial contributions and distinguished service. We will all miss Jim a lot and wish him all the best in his well-deserved retirement. And as we announced a few weeks ago, Michelle Mosier will succeed Jim as Vice President, Chief Financial Officer and Treasurer on January 1. Michelle joined the company on Monday this week and we are delighted to welcome her to our executive team. She will be working with Jim over the next two months to ensure a smooth transition. Michelle is an accomplished financial executive and has extensive background with leading consumer product companies, - leading consumer products companies and a wide variety of businesses. And we are confident Michelle’s leadership and skillset to play a key role and achieving our goals in the coming years. With that, I’ll turn the call over to Jim.

Thanks, Greg, and good morning, everyone. Greg, I’d certainly appreciate your very kind remarks and certainly after 35 years, I will miss collaborating and interacting with a dedicated, talented and hard working group of team members at Hamilton Beach and Kitchen Collection. We have, in my opinion, assembled the best team in the business and as a result, the company is well-positioned to continue making strong progress toward achieving it’s long-term growth and profit objectives. Now let me turn my comments over to consolidated results for the third quarter of this year compared with the third quarter of last year. Consolidated revenues increased 8.4% to $196.9 million, compared with a $181.7 million last year. This amount included revenue growth of 12.3% at Hamilton Beach Brands to a $172.5 million and a 9.6% decrease in revenues at Kitchen Collection to $25.9 million. As Greg said, the revenue growth in Hamilton Beach Brands is primarily due to higher sales volume in all markets but particularly in the U.S. consumer international markets. Partially offsetting the revenue increase was $1.6 million in unfavorable currency movements. And at Kitchen Collection with the ongoing downward trend and customer traffic, revenues decreased primarily due to lower comparable store sales. The closure of 15 underperforming stores since the last year’s third quarter also contributed to the decline in revenues that had a modestly positive effect in operating results. Consolidated operating expenses decreased to $39.3 million compared to $40.7 million in last year's third quarter. As Greg said, this decrease is mostly attributable to the absence this year of the $2.5 million in spin-off related cost in the third quarter of last year. Consolidated operating profit increased 49% to $11 million in the third quarter of this year from $7.4 million last year. These amounts included operating profit of $13.4 million at Hamilton Beach Brands compared with $9 million in the third quarter last year driven by increased gross profit and lower operating expenses. Kitchen Collection reported an operating loss of $2.4 million, compared with a loss of $1.6 million last year. Our consolidated interest expense was $636,000 higher than last year driven by a combination of an increase in average borrowings outstanding at Hamilton Beach and higher interest rates. Our consolidated effective tax rate was 21.3% in the third quarter of 2018, as compared to 38.9% for the third quarter of 2017, primarily due to a reduction in the U.S. federal corporate tax rate and the effective non-deductible spin-off related expenses in the prior year period. We expect our full year 2018 effective tax rate to be in the range of 24% to 26%. We reported consolidated net income of $8 million or $0.59 per share compared with net income of $4.3 million or $0.31 per share last year. These amounts included net income of $10.2 million at Hamilton Beach Brands, compared with $5.2 million last year and a net loss at Kitchen Collection of $1.9 million this year compared with a net loss of $1.2 million last year. Consolidated EBITDA for the third quarter of this year was $12.5 million and $46.4 million for the trailing 12 months. Cash on hand at September 30th of this year was $2.1 million compared to $10.9 million cash balance at the end of 2017 and $3.1 million at September 30, 2017. Consolidated debt as of September 30, of this year was $99.9 million, compared with $51.3 million at December 31, 2017 and $80.5 million at September 30, 2017. Debt increased over 2017, primarily as a result of higher inventory levels at Hamilton Beach Brands. While we made progress during the quarter in reducing the year-over-year inventory levels, our total inventory investment is still higher than we would like. But the quality of the inventory is good and we would expect to work down our inventory levels as we cycle through the holiday selling season and beyond. Let me comment on a few additional factors affecting our near-term outlook. Like others in our industry, we continue to face rising product distribution and transportation costs. However Hamilton Beach continues to implement price increases and product assortment changes to mitigate these product cost increases. The tariffs that were enacted by the United States in July and September on imports from China are expected to impact small number of Hamilton Beach products or approximately 10% of total product purchases on an annualized basis. We work closely with our customers and suppliers to manage the impact of these tariffs in a fair and balanced manner while sudden changes in tariffs that creates short-term pressures, we believe any impact will be mitigated over time. We continue to closely monitor potential future tariff actions, commodity and other input costs, as well as currency effects and we intend to continue to make additional adjustments to product prices and product placements as necessary and as market conditions permit. Regarding our outlook at Hamilton Beach Brands for the fourth quarter of 2018, cash flow before financing is expected to be significantly higher than last year’s fourth quarter. For the full year, cash flow before financing is expected to decrease significantly compared with last year as a result of expected higher net working capital at the end of 2018 and increased capital expenditures. However, Hamilton Beach Brands’ continued focus on prudent management of working capital is expected to enable us to improve cash flow before financing activities in the near-term. Capital expenditures at Hamilton Beach Brands are expected to be $1.6 million in the fourth quarter of 2018, and $8.6 million for the full year. At Kitchen Collection, we expect a substantial use of cash in 2018 due to forecasted working capital changes and an anticipated higher net loss. Cap expenditures are expected to be $200,000 in the fourth quarter of 2018 and $500,000 in the 2018 full year. On a consolidated basis, for 2018, we expect fourth quarter and full year net income to increase substantially over last year’s main periods including the effect of lower income tax expense in the absence of the provisional tax charges we recorded in 2017. As we look to 2019, Hamilton Beach Brands’ revenues are expected to increase modestly compared to 2018 as a result of a continued successful implementation of our strategic initiatives. Operating profit net income are expected to increase moderately and cash flow before financing is expected to increase significantly compared to 2018. Capital expenditures are expected to be approximately $6 million in 2019. In 2019, for Kitchen Collection while we expect revenues to be lower than 2018, and although we do not expect the business to turn profitable, we do anticipate that with the continued execution of our strategy to cost-effectively right-size the store portfolio, the operating loss and cash flow before financing are expected to improve compared with 2018. Consolidated net income in 2019 is expected to increase over 2018. In closing, I would like to summarize some of the key takeaways. Overall for 2018, we are pleased with the faster than market revenue growth momentum that Hamilton Beach Brands has experienced as a result of continued progress with each of our strategic initiatives. As we reported, we expect to mitigate any product cost inflation and the impact of tariffs through adjustments in pricing and product placements. Assuming consumer spending is at expected levels during the holiday selling period, we expect to report strong results for 2018. While Hamilton Beach Brands higher revenue growth and expected future growth has largely contributed to elevated working capital levels, we anticipate these levels to normalize over time and for Hamilton Beach Brands to generate to significantly improved cash flow before financing in 2019. At Kitchen Collection, we believe that pursuing a strategy of cost-effectively optimizing a store portfolio will lead to improved results over time. That concludes our prepared remarks. I’ll now turn the line back to the operator for Q&A.

[Operator Instructions] your first question comes from the line of Peter Benedict with Baird. Your line is open.

Hey, good morning guys. This is Justin Kleber on for Pete. Thanks for taking the question here. Just wanted to start with the top-line growth at HB, very strong, obviously encouraging to see. Could you just parse out how much do you think attributed to just growth in the overall market versus all the strategic initiatives you guys have been executing against?

Justin, this is Greg. That’s always hard to parse it too much. I will say that, certainly the overall small clients market in the U.S. is doing pretty well. But it’s very much a category-by-category success story. When the market is reacting one way or another, for us, because we are in so many categories and we’ve done a nice job with our initiatives increasing placements and promotions, not only in the U.S. but in all of our divisions. Really it’s – we feel like it’s certainly the consumer environment is helping to some degree. But in the end you need good placements, good promotions, strong selling products to drive your sell-through and the reorder. So, we think strategic initiatives are really probably the primary driver of that growth.

Okay, just following up there Greg, are you guys seeing any changes to your shelf space at existing retailers in the U.S.? I mean, I just think about all the new product introductions, I mean, are you gaining space with certain accounts? Or are you seeing any new account wins and primarily thinking about the U.S. consumer business?

In the U.S., the two things that we are focused on are really at all key retailers is increasing placements and as well as promotion support. So, I think our – really this – the breadth – the growth coming is really from growth across a wide range of customers, not one category and not one customer in particular. So, that is coming from increased placements and increased promotions supported across a wide range of customers.

Okay. Just shifting to the fourth quarter and I guess the outlook for next year, you are talking about modest top-line growth. Are you seeing something changing in the environment? Or is that you guys just planning the business conservatively and then you can react accordingly as consumer takeaway remains as strong as it has been year-to-date?

Well, as you know the back half holiday-driven business, we often will see some revenue based on retailer order patterns can shift just by a few weeks all of a sudden you have big movement between quarters. Retailers might – one year support us and one month versus another. So there is – we really had tried to always look at the back half as a whole. So, I think, we sort of mentioned in the comments that last year we had some carryover that suppressed the third quarter a little bit. And increased the fourth quarter little bit last year. But while we have a – we think really good growth across all of our divisions, there was a little bit of an easier comp in the end of third quarter because of that, when we talked about last year was a – about a $10 million carryover number. So, for this year, as we go into the fourth quarter, you really are dependent upon consumers coming in the store in expected levels. When they come into the store are they spending at expected levels and then they were spending on our products and our categories. And there is so much of the business done in the fourth quarter that is real important to really just get through the back half. So, I think the good news is we are – what we are presented in the stores, we’ve got very solid promotional support and now really it’s up to the consumers to see how that plays out. And so, I think, we are – we always like to present a middle of the road point of view to everybody. There could be downside, there could be some upside. But, right now, we think that’s probably the most clear and balanced view, middle of the road view that is what we talked about.

Okay. That makes sense. Thanks for that color. Just maybe shifting gears to the pricing environment. I know that’s in the revenue bridge in the 10-Q that higher ASPs contributed few million dollars to revenue growth this quarter. Does that primarily reflect pricing actions you’ve taken on the products that are exposed to tariffs?

Yes, I mean, that’s not really, Justin, those products that’s go to the tariffs at this stage. It’s really to offset some of the product cost inflation that we’ve seen – the headwind that we’ve seen so far this year, so.

Okay, okay. Just maybe sticking with the topic of tariffs. Aside from pricing and products, placing of juicers, are there other mitigation strategies? I am thinking alternative country sourcing that you guys are exploring in the event the administration decides to levy tariffs on all Chinese imports?

Well, I think, both Scott and I and some other folks here just got back from China. We spent a lot of time talking to our supplier base understanding what their plans are and thinking through ourselves doing a long research about what’s available out there. And, I think in the small – while some industries can move faster, I think smallest clients industry, is exploring many alternatives but it’s going to be a slow move and then there is the infrastructure around components, training. We certainly want to be very careful about quality and safety in our products. So, I think everyone is trying to make sure that they stay competitive and are building in the most competitive markets and right now I think folks are exploring options, doing a little bit of wait and see, what happens with the government decisions and the negotiations. And I think what we’ll do is we will just watch it real closely and we’ve shown over time that as production is moved to lower cost areas we follow that. And try and work real hard to make sure we are competitive and that’s what we are continuing to do.

Okay. A question on gross margin at Hamilton Beach. We saw a little bit of pressure here in the third quarter and you guys mentioned product cost, transportation cost, et cetera. Do you think – I mean, as we look to 4Q and into 2019, should we expect that level of pressure that persists? Or do you think it becomes more pronounced just given what’s going on with transportation costs and tariffs? How should we be thinking about gross margin over the - into 2019?

Justin, I think, there are definitely a lot of moving parts and I think, tariffs and product costs, you are right. Mix – customer mix, product mix. So what we’ve still feel confident in is and we’ve sort of communicated in the past that there certainly could be things like mix or growth in certain parts of our business at a higher margins could help us improve our margins. But we are really focused on and we are going to assume that our gross margins are going to say in a traditional range. We are going to grow revenue faster than expenses over time and that’s how we will spend it bottom-line. I think based on what we’ve seen each of the teams, Scott and his team here in North America and other teams around the world have done a very good job working with retailers in a way that is sort of collaborative. We pass along price increases, change SKUs to manage our portfolio with our retailers in a way that’s good to both of us. But I think we are going to just – I think we are in a position where we can keep those gross margins in that range that we’ve talked about in the past. And again, if we can – that there might be – there were some quick surprise on the tariffs certainly that might bite us in the short-term. But we don’t expect that. There we have a real strong closing, particularly in parts of our business that’s higher margin and we could see some improvement in our gross margin estimate. But right now, I think, our view would be is, we would all count on understanding in that same range. And so far, I think I feel pretty good about the fact that as we go into 2019, that we’ve worked through all these challenges and say that we are going to stay in that range.

Okay. And last question from me guys. Just on the cash flow outlook. You mentioned, free cash flow should improve significantly next year as working capital normalizes. Is that more inventory-related or do you see an opportunity with either receivables or payables as we move into 2019? Thank you.

Yes, Justin, I would say, mostly in our inventory-related. We don’t see a significant change really in the payables or receivables side. As you know receivables – given the seasonality of the business, it can move up and down, but in terms of the DSO or DPO, we always look at trying to improve that, but we are not expecting improvement to generate cash flow forecast that we just presented. So, it’s mostly on the inventory side.

All right. Thanks, Jim and congrats on the retirement.

Thanks, Justin.

[Operator Instructions] We have a question from the line of Mitchell Lolley with Nixon Capital. Your line is open.

Why do you think Kitchen Collections’ results won’t continue to worsen next year?

This is Greg. Well, we’ve – the strategy we are pursuing is, by positioning ourselves that have the majority of stores have a one year lease or less. As we get to the end of each year, we can look at the malls, the stores in the malls that are doing well, or doing better than others and look at the ones that are not doing well, and we are really in a position to close the stores that we don’t feel through lease negotiations or through other measures that we can move to a profitable position. So, we are reducing the holding margins as a strategy. We are working on reducing costs that could be allocated at the stores and then we are going to close a decent amount of unprofitable stores. And so, as we head into 2019, the company should know those things assuming some level of the traffic decline should allow us to had improved performance. But certainly if the foot traffic declines stabilize versus going down we would have maybe a little better performance and then if that worsens dramatically, then we would have a worst performance than we mentioned. But we keep moving to more and more stores as I mentioned at the end of next year, about 80% of our stores that one year or less and then we will – if we have to close more stores faster then we will do that. So, right now, our view is, we’ve got a number of steps in place. It is certainly not an easy thing to predict and it’s not an easy environment to stabilize the business and but the team has done a real nice job giving us a lot of opportunity to move into a better direction next year.

Okay. Does foot traffic worsened dramatically in 2018 versus your initial expectations, because at the beginning of this year, I think you expected the same thing, but it’s didn’t quite turn out that way?

Yes, we projected a – internally in our modeling. We projected a foot traffic decline and it was definitely worse than we expected. And I think as we talked about whole year long, we assume we get down to a 100 to 150 stores in the pace which we get down to that really dependent on the store performance and dependent on the store-by-store profit or loss. And so, the good news is, we are positioned to none of we know what the results were in hindsight. We are reacting and we think we told about it when the store makes money, we’ll keep it open, if it doesn’t, we’ll close it. And so, certainly it was more of a fall-off than we had in our original model.

All right. Great. Thank you.

Thank you.

I am showing no further questions. I will now turn the call back to Mr. Greg Trepp for closing remarks.

Thank you. As you've heard this morning, we're pleased with the continued top-line momentum driven by our strategic revenue growth initiatives and we expect our progress to continue. If Kitchen Collection continues to operate in a difficult retail environment, we are working on to further right-size the business and better position it to deliver acceptable returns. We are focused on increasing shareholder value over the long-term. So with that, I’ll conclude our call for today. Thank you everybody for joining us.

This concludes today's Hamilton Beach Brands Holding Company’s Third Quarter 2018 conference call. This call will be available for replay beginning at 12:30 Eastern Time today through 11:59 PM Eastern on November 17, 2018. The conference ID number for the replay is 5446588. Again, the conference ID number for the replay is 5446588. The number to dial for the replay is 1-800-585-8367. This concludes today’s conference call. You may now disconnect.