Hamilton Beach Brands Holding Company (HBB) Q3 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Hamilton Beach Brands Holding Company Third Quarter 2020 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would like to hand the conference over to your speaker today, Lou Anne Nabhan, Head of Investor Relations. You may begin. Thank you.

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

Thank you, Lou Anne. Good morning, everyone. Thank you for joining us. I will provide color on the third quarter in a moment, but first, I'd like to focus on the underlying strength of our business. We delivered a solid first half. While third quarter results were disappointing as a cutover to our new ERP system temporarily reduced shipping capabilities at our U.S. distribution center, we expect the elevated demand from our consumers -- our customers to remain strong over the back half of 2020 and at least into the first quarter of 2021. A large portion of the third quarter revenue shortfall is expected to shift to the fourth quarter as we focus on maximizing our shipping capabilities to capture as much of the market demand as possible. Based on early fourth quarter results, shipments are ahead of last year. The ERP-related shipping challenges have been resolved and are behind us. While the cutover was more difficult than expected, we now have a system in place that is more efficient than our decades-old legacy system, which will benefit us in future years. The small kitchen appliance market in the U.S. and Canada is growing at a rate of approximately 30% compared to 2019, driven by consumers who are sheltering at home during the pandemic and engaging in far more than usual meal and beverage preparations. We expect this demand to remain elevated into 2021 as the pandemic continues to keep people at home. Hamilton Beach Brands is well positioned to meet the unprecedented demand. Customer order levels are high, and we have the necessary inventory on hand and more in transit to meet this demand. We've been increasing the in-stock levels with our customers and shipping product at elevated levels. We held and gained placements for the holiday selling season, including many new products. We are benefiting from our leading portfolio of consumer-preferred brands and products. Even with employees working remotely, our new product development process is working well. Our robust capabilities in the growing e-commerce channel, our global infrastructure and team members and our diversified retailer relationships are important competitive advantages. Further, the retail business in Mexico and Latin America are slowly rebounding. Commercial customers in the food service and hospitality industries are beginning to order again as they adjust to the new world created by the global pandemic. We are well positioned to capitalize on the recovery in these markets. Our financial position is healthy as we have effectively managed net working capital and reduced debt. Additionally, Kitchen Collection's net losses and negative cash flow no longer have an impact on our company. We closed the business through a successful liquidation and completed the wind down earlier this year. That timing turned out to be very fortunate. While our focus is continuing to capitalize on all of the tailwinds that are driving Hamilton Beach forward in the coming months and quarters, let me take a moment to comment on our third quarter. As we communicated in our last call, we were in the early stages of cutover to a new ERP system in the U.S. At the time, we reported reduction of sales in July and an expectation to offset the July shortfall in August and September. As August unfolded, the challenges were more persistent than anticipated. We improved our shipping abilities week by week, and as we entered September, we were operating more effectively. However, the shortfall in July and August was too large to overcome in the third quarter. While the ERP challenge was the primary hurdle, a secondary factor was challenges with shipping and transportation, both inbound from our suppliers and outbound to our customers, which added to our revenue shortfall. While shipping challenges related to the ERP implementation have been largely resolved, congestion in the shipping and transportation industries persist, which is requiring us and our customers to plan differently. We have enhanced our shipping capabilities by adding warehouse personnel and lift equipment, extended shifts in augmented capacity with temporary third-party facilities. We also have been able to convert some of the order volume that our largest retail customers to direct import, which helps to ease the strain on our shipping capabilities. We are also preparing for record direct-to-consumer shipments. We are well positioned on retailers' e-commerce sites. Consumers are likely to shop online at elevated levels and we are positioned well to support our retail partners. An ongoing challenge of course is the fact that the global pandemic is still with us and likely to be for many months to come. The pandemic continues to require careful attention to protecting health and safety. We closely monitor the ever-changing COVID-19 environment globally in order to keep our business moving ahead and in compliance will all guidelines. We are deeply grateful for the efforts of our employees to stay safe and healthy, especially those who are not able to work from home. Our team has effectively navigated the global crisis and the focus, teamwork and diligence have been epic. I thank our employees around the world for the excellent work that they are doing under the ongoing difficult circumstances brought on by the virus. I'd like to recognize especially the dedication of the folks who work in our distribution centers. The demands placed on them have been immense and they have risen to the occasion. I can never thank them enough for all they have done to keep product flowing to our customers under these circumstances. Our priority has been and continues to be the health and wellbeing of our employees as they work to serve the needs of our customers and consumers. In summary, we are fortunate to be a leader in an industry that is providing essential products to homebound consumers and making their lives a little easier during these times, the tailwinds we are experiencing are providing momentum to propel our business forward for the remainder of this year and into 2021. Our team is doing an outstanding job navigating the pandemic and meeting the unprecedented demand surge. We are encouraged by our early fourth quarter results. We remain committed to protecting the health and safety of our employees as we work together to meet the needs of our customers and consumers and keep our organization agile so that we may adapt as necessary to the dynamic environment we're operating in. I'll now turn the call over to Michelle who will review our financial results for the quarter.

I, too, am very pleased with how our entire organization has faced and overcome the many challenges of 2020. Our teams have our deepest appreciation for the excellent job they're doing to fulfill customer orders at a time of unprecedented demand for our products. Throughout this year, we've maintained a range of measures to ensure financial flexibility, including eliminating discretionary expenses, implementing a hiring freeze for most open positions and focusing capital spending on critical projects. We have demonstrated effective working capital management and expect to continue to increase cash flow and reduce debt. We remain disciplined, yet opportunistic in our expense and capital investment approach, focusing on maintaining a strong balance sheet to ensure we have the necessary flexibility as we navigate these uncertain times. Now let me review our third quarter 2020 results from continuing operations compared to the third quarter of 2019 and discuss our outlook. Total revenue decreased 26%. The main reason for the decline was lower sales volume in the U.S. consumer market, which occurred as a result of greater-than-expected challenges implementing our new ERP system. While unprecedented demand continued, the cutover to the new system temporarily reduced shipping capabilities at our U.S. distribution center. Additionally, constraints in the transportation industry also adversely affected shipping capabilities. The shipping hurdles related to ERP are resolved and behind us, and operations at our U.S. distribution center are operating effectively. In the international consumer and global commercial markets, lower sales were expected and driven by pandemic-related demand softness. In the Canadian consumer market, sales volumes increased as we expected. Our operating loss in the third quarter was $2.4 million compared to an operating profit of $4.4 million last year. Gross profit declined due to lower sales volume, however, gross profit margin increased 80 basis points from customer and product mix. Selling, general and administrative expenses decreased $300,000. The decline is primarily due to lower overall spending and the benefit in the reduction to environmental reserve at 1 site. These benefits were partially offset by increases in employee-related costs due to increased incentive compensation, mostly driven by the increase in the market price of our stock, legal and other third-party fees primarily related to the irregularities in our Mexican subsidiaries and an increase in the contingent loss related to patent litigation. The 2019 third quarter includes a charge of $2.6 million to write off unrealizable assets of our Mexican subsidiaries. Turning to the balance sheet. As a result of improvement in net working capital, we have had lower average borrowings outstanding under our revolving credit facility ending the quarter with net debt of $69.6 million as compared to $78.6 million in the prior year. This along with our average interest rate has resulted in decreased interest expense. Use of cash before financing activities improved significantly compared to prior year, with the use of $8.8 million for the 9 months ended September 30, 2020, compared to use of $27.3 million for the 9 months ended September 30, 2019. Because of the seasonal nature of our business, we typically build inventory and accounts payable during the third quarter. The net impact to cash flows to the change in inventory and accounts payable is relatively consistent year-over-year. The increase in inventory is a result of a sales shortfall for the quarter. With the expected shift of sales into the fourth quarter and strong demand expected to continue into 2021, we believe that our inventory position supports us well to meet our customers' demand. Next, let me turn to our outlook. We continue to believe we are well positioned to effectively navigate the ongoing COVID-19 environment as demand remains elevated and our cost management measures remain in place. For the second half of 2020, we expect total revenue to be in line with the second half of 2019, and operating profit is expected to increase approximately 20%. Any interruptions in shipping caused by a further challenge transportation industry or unexpected ERP complications while not anticipated could cause results to fall short of expectations. The revenue outlook includes the impact of converting some order volume to direct import by customers to help ease strains on the shipping operations. Direct import sales -- with direct import sales, we recognized lower revenue as cost savings are shared with the customer. If we imported the converted orders, revenue would be higher in the second half of 2020 by approximately 8 million, which will result in modest growth. Our goal continues to be to exceed $20 million in cash flow from financing activities for the full year. Timing of some accounts receivable collections could move into the first quarter of 2021 due to timing of revenue expected to shift from the third quarter of 2020 to the fourth quarter. We will know more as the fourth quarter unfolds. Visibility into 2021 beyond the expectation of continuing strong demand in the first quarter is limited. So we're deferring any outlook for the full year 2021 to a later time. Also, looking ahead, Hamilton Beach Brands maintains a $115 million senior secured floating rate revolving credit facility that expires on June 30, 2021. As of the end of the quarter, we had not yet finalized the amendment to extend this facility. As a result, all amounts outstanding were classified as current liabilities at the end of the quarter. We're working very closely with our bank group and expect to finalize the amendment before the end of the month. I'll note that there were no share repurchases during the third quarter. That concludes our prepared remarks. We'll now turn the line back to the operator for Q&A.

[Operator Instructions] Our first question comes from the line of Peter Benedict with Baird.

A couple of questions. One, just on the fourth quarter revenue growth. It seems like it's implied up around 20%. Curious how much of that is recapturing some of the lost sales from 3Q versus kind of future reorders expected from retailers given the strong demand? That's my first question.

Peter, this is Greg. It was tough to put an exact number on that, but we certainly are still restocking shelves with certain customers, which we were hoping to do more of that in the third quarter. And there is some business that went to other competitors who had product in the shelves or online. But we have some very big promotions and programs in place with retailers that were going to ship in the fourth quarter and will continue to. So it's hard to put tough -- a hard number on that, but certainly, there is a significant amount of the third quarter that will flow over into the fourth quarter. We'll get as much out in the fourth quarter as possible, and some of that might -- if it sells through as well as we expect, there could be continued restocking going on in the first quarter.

Okay. Okay. And then just can you maybe talk a little bit about the shape of recovery you're seeing in the commercial markets, which is obviously interesting given lockdown, reopening, kind of the give and take from that. But it sounds like you're starting to see some commercial -- some life in the commercial markets. I don't know what else you can share, where you're seeing it and what your expectations are for that part of your business as you look going forward?

Sure. So the U.S. market is doing better than Europe. Europe continues to have, as you said, some pretty significant activity on locking down on and off again. Also, the European market is not as developed when it comes to drive through and take out as the U.S. has proven to be. So in the U.S. market, after a period of completely being shut down, the customers are preordering to get their facilities going in, some menu items are rolling out again, not a lot, mostly it's keeping -- or modifying their -- how they run their operations more than it is adding new menu items yet. But just modifying as required them to keep investing in replacing equipment or upgrading equipment, et cetera. So we're seeing better rebound in the U.S., slow rebound throughout Europe, but some rebound as they've opened back up and actually a pretty decent movement in China.

Okay. That's helpful. You mentioned the shipping constraints, separate from the ERP situation. Maybe just expand on that a little bit more. I mean you mentioned kind of it's inbound, it's out by -- it feels like it's all over. Just how are you guys kind of addressing that? Again, you mentioned a little bit of this in your prepared remarks. Just curious how you kind of see the, I guess, the shipping challenges or -- as we look -- particularly as we go through the holiday, just as -- and when we have the -- if there's going to be a big increase in e-commerce like there has been for the last several months, that obviously elevates the pressure on shipping channels when you get to the holiday when volumes naturally lift anyway. So I don't know. Just curious kind of how you see it and your level of confidence you can get the product where it needs to be for the holiday season?

Peter, this is Scott. I think that's -- we've got a number of different areas where the supplies have been -- supply chain has been challenged. We start with where our goods come from in China. We've definitely seen out of a number of ports over there, sailings that have been delayed for a couple of weeks. But we do have a lot of inbound inventory and a lot of inventory in our distribution center. If you look at last year at this time, we had most of our retailers that were probably picking up and sending equipment to pick up their orders on our docks in 24 to 48 hours. We now see that can be anywhere from 2 to 10 days to try to get that equipment in. So it is -- there is some congestion on our docks. I do think we're well positioned on the e-commerce side. We worked through a lot of those constraints. Our ability to ship a lot of units out of our distribution facility is certainly there, and we're ready for that increased demand. And we don't think that has the same challenge as to getting some of this inventory to some of our retailers when they're trying to get equipment. So I think that -- I think the challenges will continue for a couple more weeks on the inbound side and on the outbound side, and then we'll start seeing some relief in December.

Okay. Okay. I guess just the last one. I know on the last call, the ERP system has now come up a couple of times. And look, you're not the first company to have experiences with ERP implementations. Just -- what gives you the confidence that we now are kind of past this, and we're not going to hear about this in 3 months, but anything you can tell us that would give us confidence that, that's going to be the case?

Sure, Peter. So when we all met or had the call last time, we were working through some of the challenges and really had a work plan and a game plan and people had assignments and all the things you do to kind of say, okay, here's where we think this is going to play out. And just some of the surprises and persistent challenges getting some of those requirements fixed just took longer than we thought and then really just kept backing us up. So I think the good news is when you look at how we have performed in September, specifically in October, as we ship day-to-day-to-day, we're just not having those issues like we were back in August. So then it became more about how do you catch up and how do you deal with some of the congestion. But on a day-to-day basis, we are just -- we're -- the facility is running really well, and it's not being impacted by the ERP system in a negative way.

[Operator Instructions] And there are no further questions in queue at this time. I'll turn the call back over to Mr. Trepp for closing comments.

Thank you. It remains a challenge to manage through the COVID-19 situation. However, we have demonstrated an ability to successfully navigate the global pandemic. While we have not dealt with the pandemic before, we have managed through challenging situations in the past and emerged as a stronger company each time. This crisis has clearly demonstrated what a capable global team our company has. We remain committed to the safety and well-being of our employees and to meeting the needs of our customers and consumers as we all work together to keep our organization agile and able to respond quickly to changing needs and circumstances. In addition to benefiting from the ongoing unprecedented demand for small kitchen appliances, as people continue to shelter in place, our industry is increasingly optimistic that the new habits that have been formed will drive healthy post-pandemic demand. All this is in our sweet spot, and we are optimistic and excited about the future of our business. Despite some challenges we have faced and overcome this year, all signs point to finishing this year strong and continuing momentum into 2021. Thank you again for joining us on our call today.

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