Hamilton Beach Brands Holding Company (HBB) Q3 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen thank you for standing by and welcome to the Hamilton Beach Brands Holding Company Third Quarter 2019 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speakers' presentation there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today; Lou Anne Nabhan, Head of Investor Relations. Thank you. Please go ahead.

Thank you Jodi and good morning everyone. Welcome to our third quarter 2019 earnings conference call and webcast for Hamilton Beach Brand Holding Company. Greg Trepp, President and Chief Executive Officer; and Michelle Mosier, Vice President, Chief Financial Officer and Treasurer will discuss the company's third quarter results and our outlook. Also present for the Q&A will be Al Rankin, Chairman of Hamilton Beach Brands Holding Company and Scott Tidey, Senior Vice President North America Sales and Marketing for Hamilton Beach Brands.Yesterday after the market closed, we issued an earnings release announcing our third quarter results and filed a 10-Q with the SEC both documents can be found on our 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 in 10-Q. The company disclaims any obligation to update these forward-looking statements which may not be updated until our next quarterly conference call if at all.I'll now turn the call over to Greg.

Thank you Lou Anne and good morning everyone and thanks for joining our call. My comments will focus on our Hamilton Beach Brands segment, while Michelle will discuss our consolidated results and Kitchen Collection. I'll take a few minutes now to provide some high level comments about Kitchen Collection.As I'm sure you read on October 15, we announced the Kitchen Collection would wind down its retail operations and close all of its 160 stores by the end of the year. Sales began at all stores soon after the announcement and will continue through the holiday selling season. While, it's early in the process the wind down is in line with expectations.As we've discussed previously Kitchen Collection had been taking steps for some time to enhance its position and prospects by reducing in store portfolio to a core that was expected to support longer-term profitability, while operating losses have moderated in the first half of 2019 compared to last year. Kitchen Collection continued to experience decreased comparable store sales resulting from a decline in foot traffic.Despite our best efforts to return Kitchen Collection to profitability through store count consolidation further deterioration in foot traffic lowered Kitchen Collection's outlook for the prospects for future return to profitability and positive cash flow generation.We evaluated strategic alternatives to maximize the value of the business and reached the difficult, but necessary conclusion that it was in the best interest of the company and all of its stakeholders to wind down the business by the end of 2019. We're deeply grateful to all of our Kitchen Collection employees for their hard work and dedication during a difficult time and we commend their efforts and professionalism in conducting an orderly wind down process.The difficult as this action is for the kitchen collections 800 employees the move should be positive for shareholders. The wind down is occurring at a time of year when we should be able to capture the most value from the inventory.Additionally, our strategy for moving the vast majority of the stores to a one-year lease term also improves our ability to wind down. We expect that over time the benefits of this move will become evident in our market value.Now let me turn to Hamilton Beach Brands segment. You may recall that during our second quarter earnings call, we reminded everyone that in 2018 we had a strong third quarter and a softer fourth quarter and that we expected the 2019 fourth quarter to be stronger than the third quarter.We noted that with the seasonality of our business, retail orders can move up or back by a few weeks and these small ships can have a big impact on a particular quarter. In fact not only did we experience the usual timing shifts in our U.S. Consumer business we experienced a significant change in retail order patterns driven by the adverse impact of tariffs.That is a very detailed discussion that I'll get into in a moment. I will add for now that because of a lot of the third quarter revenue decrease was due to timing issues, we expect to recover a large portion of it in the fourth quarter.First let me quickly provide the key highlights of third quarter results for Hamilton Beach Brands. Revenue was $150.9 million compared to a very strong 2018 third quarter when revenue reached a record $172.5 million. The shortfall was across all of our markets except for global commercial.Gross profit margin decreased to 20.7% from 22.3% due to higher inbound freight costs, increased transportation and warehousing expenses and the adverse impact of tariffs. This along with lower sales volumes led to a decrease in operating profit.In addition to the expected difficult comparison to last year, the shortfall was due to a number of issues starting with the adverse impact of tariffs. Some of you may recall that on the same day as our last earnings call August 1 new 10% tariffs were announced on all remaining goods imported from China, List 4 and the effective date was September 1st.Couple of weeks later, it was announced that the List 4a will take effect on September 1st and List 4b would be delayed until December 15th to avoid disruptions to the holiday season. Week after that the tariff front List -- all List 1 through four products would be increased by 5% meaning that List for 4a and 4b would increase from 10% to 15% as of their respective dates List 1, 2, 3 would increase from 25% to 30% on October 1st.September the 5% increase unless one to three were delayed until October 15th and then it was later suspended. That timeline illustrates the short notice and abrupt changes faced by all companies affected by the tariffs and has been very disruptive to us our customers and our suppliers.Understanding the timing and the level of the tariffs mitigating the impact of these tariffs in a way that minimizes the disruption to our retail partners, just as the key holiday order season begins is a significant challenge and resource strain.Additionally, due to the List 4a implementation date coinciding with retailer holiday order timing, our customers have been less open to tariff-related negotiations. The process has taken much longer to finalize that it did for List 1, 2, 3. We have mitigated a significant portion of this foray, but the timing of mitigation varies. So the ultimate impact will be determined in the coming weeks and months.As a List 4 tariffs are layered onto our business the impact has become much more meaningful. As we've stated before List 1, 2, 3 had a relatively small impact on our business approximately 10% of total purchases on an annualized basis. That impact was mostly mitigated.List 4a which captured the large coffee maker category among others increased the impact to approximately 25% of company purchases annualized. List 4b will increase the amount to approximately 70%. I'll note that the tariffs impacted our U.S. consumer business and our U.S. foodservice business and hospitality businesses.As further evidence of how fluid the situation is, there is news this morning of potential progress in the trade talks. We will adjust as announcements become official. Another unfavorable impact of the tariffs is that, in our U.S. consumer market nearly 50% of the third quarter revenue decrease was due to lower direct import sales.Before the List 4 tariffs retailers were more inclined to take ownership of some inventory directly from our suppliers in China which has the benefit of a modest cost savings to the retailer and earlier revenue recognition to us.However in order to avoid the full impact of tariff increases retailers having increasingly opted to take ownership of inventory from our U.S. warehouse transferring the tariff impact to us. This shift can add up to five weeks to the date on which we recognize the revenue which is how we experience a significant revenue timing shift from the third quarter to the fourth quarter a portion of our revenue.As long as the current tariffs remain in place, we utilize a number of strategies to offset the impact of tariffs focusing all as a package to improve gross margin percent over time.For example, we negotiate with suppliers for cost concessions, we apply for exclusions we were successful in obtaining some limited exclusions last year for certain products and we also benefited from some exclusions obtained by other companies. We are working on a List 4a exclusions under the process that's just opened.We continue to explore options with respect to qualified suppliers from a number of countries which is part of our normal sourcing process.Tariffs are only one factor that we would consider in determining whether a supplier is qualified to manufacture our products. There is a significant small kitchen appliance manufacturing infrastructure set up outside China, and it will take time to establish that. HBB has moved production many times over the years, so we are confident we can sort of successfully moved production if needed.Finally, we are passing along price increases where possible. In addition to the tariffs other issues that contributed to the third quarter revenue decrease including, a loss of placements in the dollar store channel resulting from a decision we made to not compete to maintain some very low margin business. Also, food traffic challenges at some retailers, and other pressure points facing individual retail companies had a negative impact on U.S. sales in the third quarter.In our International Consumer Markets, the lower sales volume was due in large part to a one-time special purchase in 2018 by a customer in Latin America, and to a lesser degree to reduced demand in several markets. At the same time, there are many bright spots in an otherwise difficult quarter. For example, our global e-commerce revenue continued to grow in the third quarter – excuse me – and the star rating performance of our brands and products across retail channels continues to be four star and above on average.In e-commerce, the Hamilton Beach Brand remains number one in units in small kitchen appliance category. In 2019, we expect to generate e-commerce sales growth in all of our markets. Our global commercial revenue increased in the third quarter. As we reported we're working to accelerate sales growth from our commercial products around the world. We've been growing at a rate of 6% annually, and the team is building programs designed to increase the rate over time to more than 10% annually.One of the elements of the program is increasing feet on the ground in fast growing or under-developed markets. We have several new team members in place that will provide extra focus on Asia, e-commerce sales and marketing, in the hospital, culinary school and education markets. Our Only-The-Best brand's revenue increased in the third quarter driven by our Wolf Gourmet and Hamilton Beach professional products and the new partition premium cocktail delivery system that we began selling early this year.We're on track to introduce 70 to 80 new product platforms this year, and we have introduced several new products that we expect to be popular sellers for the holidays. Some of our new air fryers were introduced earlier this year, and we're also introducing three more air fryers and four pressure cookers making us well represented in brands and sizes.Our new Hamilton Beach Brand, Digital Sure-Crisp air fryer toaster oven a multi-function appliance is being particularly well received. Another new item that will roll out in early December is an innovative egg-bite maker, a small appliance that will enable consumers to easily make this popular coffee shop item at home.Also, at this holiday time of the year, we're benefiting from our leadership position in a number of categories for traditional items like hand mixers and can openers, which we offer with a variety of special features and consumer-friendly functionality.From a new category perspective, we just entered the Oral Care category, which is a large and growing presence in the e-commerce channel, with the sonic rechargeable toothbrush under the Brightline brand name. Our product received the American Dental Association Seal of Acceptance, one of the few brands to have that sanction, which would be a strong selling point.We're very excited that the initial online ratings averaged 4.5 stars, including a lot of five star ratings and reviews are very favorable. All these exciting new developments give us confidence that our strategic initiatives have strong potential to drive long-term growth in our core business and in new areas.I'll now turn the call over to Michelle.

Thank you, Greg, and good morning, everyone. I'll discuss the quarterly results for Kitchen Collection, our consolidated results for the quarter, and then I'll review our outlook for the full year 2019. Kitchen collections third quarter revenues declined $20.3 million from $25.9 million last year, due to the closure of 37 stores and to lower comparable store sales.An operating loss of $3.1 million included a $1 million impairment charge and compared to a loss of $2.4 million last year. As previously reported, Kitchen Collection expects to incur expenses in the range of $4 million to $6 million, during the fourth quarter primarily for severance obligations and professional fees related to its wind down.Total cash expenditures related to the wind-down, excluding cash expenditures in the ordinary course as Kitchen Collection, continues to operate are expected to be in the range of $6 million to $8 million. These charges and expenses do not include lease termination obligation as the amount is subject to negotiation and it's not known at this time.Our estimate of the charges and expenses is preliminary and subject to change until finalized. We expect that the historical and future financial results of Kitchen Collection will be classified as discontinued operations in the period during which the assets are abandoned, which we in currently anticipate to occur during the 2019 fourth quarter.In connection with the wind down of Kitchen Collection and Wells Fargo got into a forbearance agreement, with respect to the Kitchen – and secured revolving line of credit. Under the terms of the agreement Wells Fargo has agreed to forbear from exercising its rights and remedies as a result of the events of default resulting from the decision to wind down the business, pending payment in full on or before December 15th, 2019. Hamilton Beach Brands Holding Company has not guaranteed any of the obligations of Kitchen Collection under the credit agreement.Turning to our consolidated results, revenue was $169.8 million compared to $196.9 million last year, and reflected the 12.5% decrease in Hamilton Beach Brands and a 21.6% decrease of Kitchen Collection. Consolidated gross profit was $40.6 million compared to $50.4 million last year.Gross margin percent declined 23.9% from 25.6% last year, primarily due to the decrease at Hamilton Beach Brands that Greg discussed earlier. Consolidated selling, general and administrative expenses decreased $3 million or 7.7% to $36.2 million from $39.2 million last year.Despite the impairment charge of Kitchen Collection their SG&A decreased by $1.8 million as a result of the benefit of closing unprofitable stores, and lower corporate expenses. Hamilton Beach Brands' SG&A also declined primarily as a result of lower legal and professional services fees related to the patent litigation. Interest expense net decreased $100,000 primarily due to decreased average borrowings outstanding under both of the Hamilton Beach Brands and Kitchen Collection credit facility.Consolidated income before income taxes was $2.5 million for the third quarter of 2019 compared to $10.2 million for the third quarter of 2018. Income tax expense was $2.1 million compared to income tax expense of $2.2 million last year. The current quarter included $1.9 million of deferred tax expense related to establishing evaluation allowance against certain deferred tax assets of Kitchen Collection. Consolidated net income was $400,000 or $0.03 per diluted share compared to $8 million or $0.59 per diluted share for the third quarter of 2018.Turning to our balance sheet and cash flow, as you know we've been focused on getting our inventory, debt and cash flow back to our desired levels, with inventory being the key element. Consolidated inventory at September 30, 2019 was $181.8 million down slightly from $183.8 million last year. Inventory at Kitchen Collection decreased $7.3 million, due in large part to the store closures.At Hamilton Beach Brands, inventory increased slightly to $161 million this year from $155.7 million last year, due to anticipated fourth quarter needs. As Greg discussed, we saw a change in the retailer order patterns, which resulted in an increase in inventory due to timing. Consolidated use of cash before financing activities was $38.4 million compared to $53.8 million for the first nine months of 2018. The improvement reflected an $11.4 million decrease in net cash used for operating activities in the first nine months of 2019.Capital expenditures were $3.3 million in the first nine months of this year, compared to $7.2 million last year, primarily due to lower capital expenditures related to internal-use software development costs and tooling for new products.Consolidated debt at September 30, 2019 was $89.7 million compared to $99.9 million last year. The decrease was due primarily to lower net borrowings at Hamilton Beach Brands. We continue to repurchase shares in the third quarter. Our currently authorized share buyback program runs to the end of December and is for the purchase of up to $25 million of our outstanding Class A common stock. In the third quarter, we repurchased 235,206 shares for an aggregate purchase price of $3.6 million. Since the inception of this program, we have repurchased a total of 364,893 shares for an aggregate purchase price of $6 million.The Board of Directors has approved a new stock repurchase program providing for the purchase of up to $25 million of our outstanding Class A common stock, which starts on January 1, 2020 and runs through December 31, 2021. And now let me turn to our outlook for Hamilton Beach Brands.Based on early fourth quarter results, we expect to recover much of the third quarter revenue decrease. The extent of the recovery will ultimately depend on retail and consumer response to increased product cost and higher prices at retail caused by the tariffs.For the full year 2019, we expect revenue to be approximately even with 2018. Operating profit is expected to be in the range of even to a modest decrease compared with 2018. Cash flow before financing activity is expected to increase significantly in 2019 compared to 2018, as we continue to work toward a goal overturning to pre-2018 levels of exceeding $20 million.However, the timing of accounts receivable collections could move into the first quarter 2020 due to the impact of certain revenue shifting from the third quarter to the fourth quarter. Capital expenditures are expected to be $4.3 million.Looking ahead to 2020, we believe that progress with our strategic initiatives will continue to support our long-term growth goals. We expect improvement next year to compare to 2019 in revenue, operating profit and cash flow before financing activities.However, due to the unknown impact of tariffs and the response of retailers and consumers to tariffs, the extent of improvement cannot be fully anticipated at this time. We will provide an update on our expectations for 2020 -- fourth quarter results.That concludes our prepared remarks. We'll now turn the line back to the operator for Q&A.

Thank you. [Operator Instructions] Our first question comes from the line of Justin Kleber of Baird. Please go ahead. Your line is open.

Yeah. Thanks. Good morning guys.

Good morning.

I wanted to first follow-up on the direct import sales comment. Can you give us a sense as to the mix of revenue historically that comes from retailers directly importing the product versus more traditional fulfillment from your U.S. distribution centers?

It varies by year. So it really depends on the retailer's desire to focus on that one year to the next. But we -- right now as we've looked at what we think the comparison is based on our promotions of this year and our order pattern this year it's roughly half of the U.S. consumer mix. So it's a number really that can affect a percentage of our business, but it's not something that's the majority of our business.

Okay. Thanks Greg. And then I guess as it relates when you say the retailers realize cost savings by taking possession of product in China, is that just because they can move it from China at a lower cost than you? Or it's an inboard -- inbound transportation savings or is there something else? What's creating that cost favorability to the retailer?

Sure. So it depends on the event or the type of order that it is they have our internal models that they put it through. We feel like we're very efficient and bringing it in with our container rates and handling it through our distribution system. But by moving it through to our DC in and then having to either come get it or we ship it to them, there is extra transportation and steps involved. If we pass those along on certain events, when it gets into their systems, they can distribute in a way that helps them save a small amount.We don't think it's a dramatic amount, when they put it through their models for big large orders in the fourth quarter. It looks like you can save them a percent or 2% or 0.5% then we'll make a decision whether they want to take that in and take the inventory risk earlier.

Okay. So it's just cutting out one step in the distribution process. Exactly, right. Okay. That's helpful.

Yes.

And then maybe another question around tariffs and as it relates to just the cost increases that you're trying to push through. Are you already trying to pass through increases in anticipation of List 4B going into effect in December? Or are the actions to date really been more so in response to tariffs that are currently in place?

Hey, Justin. This is Scott. So, on the tariff side of things, we are looking and preparing if 4B were to go into effect on December 15, but those increases aren't in place. We do have some retailers that require a certain amount of lead-time to price increases. So we take that into consideration, but we're going to be able to get closer to that date and better understand what may be happening.But we are going to be prepared in case it does happen and work with our retailers to let them know what those prices would be if those tariffs were to go in place December 15.

Okay. Maybe shifting gears just a bit any way to quantify the impact? You mentioned the decision to walk away from some of the dollar store channel business. And was that a material impact here in the quarter or as we look out the fourth quarter?

We still have a little bit of it. We're about 50% of that loss is going to be in the back half of this year. And so we've got a little bit more to go. We got a little bit that will continue into the first quarter, but I think as we indicated while the other revenue dollars were there the margin dollars are very minimal in total on it and we think we'll be passed it in the first quarter of next year.

Okay. And as you just think about the holiday season and how things are shaping up in terms of placements and the mass channel, you feel pretty good about how things are looking for the holiday season from that standpoint and placements perspective?

Sure. Again, this is Scott. I'm looking at U.S. consumer in Canada. I think we feel like our holiday promotions are well in place some of the retailers are already leaking out their Black Friday promotions and trying to start things a little bit earlier since Thanksgiving falls a little bit later this year. But we look at overall distributions and promotions and we feel like we're in a good place to claw back some of the declines that we had in the third quarter.

Justin, this is Greg. Just as we you think about the wording that Michelle provided on, how we think the full year will end up based on what we think will happen in the fourth quarter.What we did is account-by-account, division-by-division, built our view of the fourth quarter. And try to make that as middle-of-the-road, as we could. We then said, okay, well, if it doesn't work out the way we think, what is the downside to that?And took some revenue off of that and used those two numbers the middle-of-the-road view and the downside to clarify our view of how the year would be. And so when Michelle said, we expect revenue to be approximately even with 2018 and operating profit will be in a range of even to modest decrease, compared to 2018.That takes into account that range of potential numbers. If there is a negative reaction in some way to price increases or foot traffic or anything in that might reduce it from our downside, then we would not hit that estimate and that guidance.And if things were, sell through a little stronger we could be a little bit. But we feel that's kind of sitting here today, that's our best view of how we could end up.

Yeah. That makes sense. Thanks for that color, Greg. Just the last question as a follow-up to that, as I think about those updated guidance parameters and what it implies for the fourth quarter.It seems like the outlook would embed a pretty material increase in gross margin during the fourth quarter, which is obviously a reversal from what the experience has been year-to-date.So what's changing in the fourth quarter? Is it simply, a cost leverage on higher sales or is there something else going on within gross margin that we should be aware of, in 4Q? Thank you.

Yeah. That's could be definitely leverage is a big part of it. We make the vast majority of our profit in the back half of the year when we have such a high volume with that volume now shifting in the larger way to the fourth quarter, that's going to provide even more leverage.We do feel like we do happened to sell some higher-end product in the fourth quarter that helps, but the majority of that increase is due to just a higher volume at that time of the year.

All right guys. Well I appreciate the time. And best of luck over the holidays.

Thank you, Justin.

And our next question comes from the line of Todd Lechtenberger of Amalfi Investments. Please go ahead. Your line is open.

Thank you. Good morning, guys. How should we follow-up on a, lower direct import sales? Help me understand. So, instead of them being the retailers taking the product in China and that's when you recognize revenue. They're saying - we understand is they're saying, ship it over here. And then, we'll take delivery once it gets some here.And so there's a four or five six weeks delay to get it over on the boat. But you guys don't -- if I remember correctly, don't you take possession of the inventory, when it crosses the rail in China?So that would lead me to believe that there would be an uptick in the inventory that you have. But there's only about a $5 million increase in inventory. Just help me understand on how that works a little bit better.

Sure. As far as the methodology, we do take -- we do recognize ownership of the inventory when it crosses the rail in China, when we're the importer. If the customer is the importer, then that moves to their books not our books.The other progress we're making in inventory is really coming from the fact that last year we were too high in inventory. And we were sort of working that down all year long. We came into this year, in a better position.But not what we needed to be and we've just been working very hard to get that back into our normal range. So really the inventory comp period that you're looking at is really one that was too high last year and is better this year.Now, if we hit our sales number it would be even lower, because we bought inventory to support a little stronger business in the third quarter, as we went into the quarter and during the ordering period.But with all the change that we just talked about that shifting into the fourth quarter, so we'll move that through we believe, in good order here in the fourth quarter.

Okay, thanks, guys. Thanks Greg.

Thank you.

And there are no further questions in the queue. At this time, I will turn the call back over to Greg Trepp.

Thank you. I'd like to leave you with a few key takeaways. As we close in on the end of the year, we have many positive things happening in the business. And our teams continue to execute the creativity and professionalism that we believe will win over time.We're looking forward to entering 2020 focused entirely on, Hamilton Beach Brands. As our Kitchen Collection business will be closed. Many of the short-term issues we're experiencing will be addressed or behind us, although we potentially have the 4B tariffs to address in early 2020.We remain very optimistic about our longer-term opportunities and the potential for our six strategic initiatives to drive significant growth. As a reminder, these initiatives are outlined in detail, in our earnings release in the section called Investor Perspective.With that, I'll conclude our call today. The holidays are just around the corner. And I wish you and your families, a wonderful season. Thank you for joining us.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.