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Edited Transcript of SIC.OQ earnings conference call or presentation 8-Aug-19 1:00pm GMT

Q2 2019 Select Interior Concepts Inc Earnings Call

Aug 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Select Interior Concepts Inc earnings conference call or presentation Thursday, August 8, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Nadeem Moiz

Select Interior Concepts, Inc. - CFO

* Tyrone Johnson

Select Interior Concepts, Inc. - CEO & Director

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Conference Call Participants

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* Alexander John Rygiel

B. Riley FBR, Inc., Research Division - Analyst

* Matthew Schon McCall

Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the Select Interior Concepts 2019 Second Quarter Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Nadeem Moiz, CFO. Thank you, and you may begin, Mr Moiz.

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Nadeem Moiz, Select Interior Concepts, Inc. - CFO [2]

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Thank you, operator. Good morning, everyone, and welcome to our second quarter 2019 financial results conference call. Joining me on the call today is Ty Johnson, our Chief Executive Officer.

During our discussion today, we'll be referring to our earnings presentation, which is available on the Investors section of our website.

I'll start with Slide 2, where I'd like to remind everyone that any forward-looking statements contained in this presentation or commented on today are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially because of issues and unknowns that need to be considered in evaluating our financial outlook and operating performance. Please see our recent SEC filings, which identify the principal risks and unknowns that could affect future performance. We assume no obligation to update publicly any forward-looking statements. Specific conditions, issues and unknown factors that may represent forward-looking statements are noted in detail on the slide.

In addition, we'll be discussing or providing certain non-GAAP financial measures today, including adjusted EBITDA and adjusted EBITDA margins. Please see the appendix for a reconciliation of these non-GAAP measures to their comparable GAAP measure.

I would now like to turn the call over to Ty Johnson, our CEO.

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Tyrone Johnson, Select Interior Concepts, Inc. - CEO & Director [3]

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Thanks, Nadeem. Good morning, everyone, and thank you for joining us today. I will begin with an overview of second quarter 2019 highlights. Nadeem will follow with a review of our financials.

In August, we celebrated our first anniversary since becoming a public company. During that time, we have produced meaningful growth in sales and adjusted EBITDA. The structural advantages of our business model and our expanding footprint have allowed us to strengthen our leadership position in a growing number of markets. Our cross-selling activities and acquisition integration efforts have generated additional benefits as we continue to scale our business.

Our second quarter performance builds on this progress. We are pleased with our overall performance, which was driven by market share gains and solid execution. On the backdrop of a slower housing environment, our sales momentum continued to outpace the level of activity in our key markets.

Second quarter sales increased 27%, generating an attractive adjusted EBITDA margin of 10.5%. Excluding incremental corporate public company and infrastructure costs, adjusted EBITDA margin improved by approximately 20 basis points year-over-year, helped by favorable operating leverage. Acquisitions contributed to these results as well and reinforce our ongoing strategy to diversify across geographies, product categories and channels.

From our leading positions in 15 of the top 20 metropolitan areas in the country, we are on a solid trajectory to continue driving growth and improvements on numerous fronts.

Turning to Slide 4. During the quarter, we experienced double digit sales growth and gross margin improvement in both our installation and distribution businesses. At Residential Design Services, or RDS, we design and install flooring, countertops, cabinets and other high-end products. We grew RDS sales 36% year-over-year. Over the past year, we have significantly diversified the service capabilities and geographic reach of this business into several new markets, resulting in fairly sizable growth during the quarter.

Today, our markets outside of Southern California represent over 2/3 of RDS revenue compared to approximately half a year ago. In addition to a host of additional cross-selling opportunities and access to new customers, our diverse footprint provides increasing stability in our business as we move forward. Across our broader footprint, our pace of construction activity remains favorable in key markets, including Arizona, Virginia and Northern California. We continue to see healthy bidding activity as we further penetrate markets and ramp up cross-selling efforts across core trades of flooring, cabinets and countertops. As such, our total RDS backlog have strengthened each month through June. And this provides us with visibility well into 2020.

A growing number of builders are targeting entry-level and mid-priced homes. Given our experience across various home price points, we expect to benefit from increased volume and drive operating leverage through our technology investments and mix enhancing solutions. Through our Architectural Services Group, or ASG segment, we are a leading nationwide distributor of natural and engineered stone and related products.

During the second quarter, we grew sales in this segment by 16% year-over-year and delivered all around great results. We benefited from a favorable pricing environment for quartz products, improvements in product mix and a positive contribution from greenfield locations.

Repair and remodel markets are stable to positive in most markets, providing an encouraging macro backdrop for ASG as its largest end market. For second half 2019, we have announced targeted price increases in select markets, which continue to adjust to supply disruptions following tariffs on Chinese imports of quartz countertops.

Across both of our segments, we are making progress on key initiatives designed to enhance our operations. Both RDS and ASG are on track with their ERP implementations and other integration-related activities. Lean initiatives and working capital improvements are amongst our top priorities. These efforts are driven by our commitments to best-in-class service to our customers and generating strong financial returns.

On the M&A front, we continue to pursue high-quality add-ons to further consolidate our fragmented industries and solidify our premier market positions. We are disciplined in our approach and target attractive opportunities that support our diversification strategy across geographies, product categories and channels at the right price.

In June, we were pleased to be added to the Russell 3000 Index, representing another milestone in recognition of our rapidly growing company. We are excited about our progress to date and we are laser-focused on executing our plan to continue scaling and capturing share in attractive markets.

We have a strong team, market-leading positions and the infrastructure for long-term sustainable growth and value enhancement for our shareholders.

With that, I will turn the call over to Nadeem.

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Nadeem Moiz, Select Interior Concepts, Inc. - CFO [4]

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Thank you, Ty. Second quarter results were in line with our expectations and represented good progress year-to-date against our plan. We achieved market share gains, gross margin expansion and higher reported and adjusted EBITDA. This reflects our strong position in key markets and our highly complementary acquisitions. Further, we ended the quarter with significant capital resources to continue executing our growth objectives.

Now moving to Slide 5, a review of net sales. Net sales for the second quarter increased $33.5 million or 26.8% to $158.3 million compared to the prior year. During the quarter, we expanded share in new geographies, increased product offerings, ramped up greenfield sites and improved overall price mix.

Acquisitions added $31 million or 25% to the sales growth. Organic growth added $2 million or roughly 2% to the top line, which represents outperformance versus our estimate of market activity levels.

Looking at our segments. In our RDS segment, sales growth of 36% was driven by acquisitions. RDS organic sales growth was positive in all regions, except Southern California as expected. Our continued efforts to rapidly diversify our RDS geographic footprint over the past 1.5 years have yielded positive results as we gain share and pick up cross-selling opportunities and recently completed acquisitions.

In ASG, growth of 16% was driven by favorable organic volume and price mix with marginal contribution from acquisitions. Volume increases in ASG were primarily driven by repair, a new model activity, which represents roughly half of ASG in market mix. Further expansion in the robust repair/remodel market remains a key objective of our growth efforts in this segment. Price and mix improvement underscore our efforts to maximize pricing opportunities and key product categories with attractive margins.

Moving to Slide 6. In the second quarter, reported EBITDA increased to $12.2 million from $7.7 million in the prior year. Adjusted EBITDA rose 20.3% to $16.6 million compared to the prior year. Acquisitions were margin accretive and added $4.8 million to the adjusted EBITDA. All through for] EBITDA from organic sales growth was unfavorable due volume and mix shift in RDS, which more than offset the performance in ASG.

With respect to gross margin, we were pleased to report that gross margin increased in both segments with an overall increase of 30 basis points to 27.9%.

SG&A and other expenses, excluding the impact from acquisitions, increased by $1.6 million, of the increase, $1.3 million was related to incremental SIC corporate costs and public company infrastructure, which was built out by the end of 2018, but not fully in place in Q2 2018.

Normalizing for incremental corporate costs that were not experienced in Q2 2018, adjusted EBITDA would have improved by 20 basis points, reflecting the strength of our core operations.

For the quarter, our GAAP net income was $1.2 million. This included other expense of $1 million, primarily driven by a change in fair value of future earn-out payments for completed acquisitions. This change is a result of mark-to-market adjustments of earn-outs on our balance sheet, which are performed each quarter by a third party for accounting purposes and recorded in other income on our P&L. Accordingly, changes in fair value macro from period to period, which will be reflected in reported net income. GAAP net income also included among other noncore items, a pretax expense of $890,000 for professional fees related to our previously announced strategic alternatives review.

The effective tax rate for the quarter was 8.9% on pretax income of $1.3 million. On a year-to-date basis, the effective tax rate is 33%, and we expect our full year 2019 tax rate to be approximately 28%.

Moving to Slide 7. Year-to-date, cash flow from operations was $8.8 million compared to a modest outflow in the prior year. Operating cash flow in the second quarter 2019 included $2.2 million of earn-out payments for past acquisitions, which are performed in line with expectations. We remain very focused on generating cash flow and improving working capital efficiency.

We ended the quarter with a solid capital position, consisting of total liquidity of $55.3 million and net debt of $189 million. Our net debt to LTM pro forma adjusted EBITDA ratio was 2.8x, keeping us at a fairly conservative leverage profile with significant capital resources to allocate effectively.

Moving to Slide 8. Our 2019 key objectives to deliver a meaningful sales growth, pretty stronger adjusted EBITDA and increased margin remain on track. For better comparability of our operational performance and current structure, sequentially from Q1 2019 to Q2 2019, we have increased sales by $21 million or 16%. During the same time, adjusted EBITDA increased by $4 million or 33% and adjusted EBITDA margin increased by 140 basis points.

Based on the slow starts in the housing activity so far, we now anticipate new construction growth for full year 2019 to be flattish versus prior year with repair/remodel up slightly. We expect that collective benefit of completed acquisitions, share gains and price mix enhancements to contribute favorably to our second half results and drive operating leverage.

Finally, I would like to thank the entire SIC team for making significant progress during our first year as a public company, and I look forward to continue executing our strategy of margin enhancement and growth.

Operator, we would now like to open up for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Alex Rygiel with B Riley.

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Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [2]

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Nice quarter. Ty, last quarter, you talked about a number of successful key wins. Can you comment on your success in the second quarter? And how that's developed year-to-date? And what your outlook is over the next 6 months with regards to new key wins with clients?

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Tyrone Johnson, Select Interior Concepts, Inc. - CEO & Director [3]

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Alex, happy to address the questions there. So when you look at it, -- let's take one business at a time. RDS continues to create advantages in the marketplace by virtue of its service, labor availability, broad product line. And based upon that, new customer attainment has been something that we've been very proud of. In Northern California, in particular, there are a number of new customers that, in fact, we've never done business with before that are now customers. Even in Southern California, where the market's a little bit softer, we continue to enjoy new business opportunities there. We're cross-selling products, Alex, across our new divisions, whether that's cabinets or countertop for flooring. That's creating opportunities for new customers. So I will tell you that similar to the first quarter, the business continues to win share, to gain share by virtue of all the initiatives that we've put into place.

And when you look at ASG, the dynamic is very similar. Certainly, with the dynamic of quartz supply, we've been able to grow very rapidly, given our consistent supply. The business has shifted more emphasis around the higher end. And as you can see, price has been something that we've been able to leverage. So both businesses have been growing very, very rapidly by virtue of new product introduction, new customer attainment and then focusing on kind of mix enhancements.

The last piece of it is greenfield, Alex. ASG's benefited greatly from the locations that we stood up last year, North Austin, Phoenix and Boston. So all in all, I think the business has done really well by virtue of us executing on those communicated initiatives, and it's starting to pay back.

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Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [4]

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Very helpful. You mentioned tariffs a couple of different times. It's been a big topic across your peer group and on the news. Can you summarize how tariffs have affected your business, both good and bad?

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Tyrone Johnson, Select Interior Concepts, Inc. - CEO & Director [5]

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Yes, sure. As we've mentioned on this call and in other forms, ASG hasn't been overly impacted by tariffs, given the relatively low exposure we had to China to begin with. That being said, we were able to successfully shift some of our imports to other countries. And for the most part that has been successful. We continue to look for and work with additional suppliers around the world to build redundancy in the supply chain. But sitting here today, we've been one of the benefactors, quite honestly, of maybe some of the disruption that others have felt as it relates to tariffs being implemented.

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Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [6]

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And can you expand upon that? Has the market price -- obviously, there had to be a massive market dislocation, but has the market price changed materially for the quartz product?

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Tyrone Johnson, Select Interior Concepts, Inc. - CEO & Director [7]

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Yes. I would say, it depends on the market, Alex. What we've seen is within certain markets where there are shortages, and with our consistent source of supply, we've been able to be very aggressive with price in those markets. We've also seen a lot of share gain as a result of a lack of supply amongst some of our competitors. We've got a fair amount of product that comes from one source in Asia that was consistent, has not been disrupted. And as a result, that business has been growing very, very rapidly. So part of the dynamics that have benefited us are in certain markets, we're able to go and really drive price and in other markets, we're able to gain a fair amount of share because (inaudible) have consistent supply.

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Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [8]

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And then one other question. As it relates to the RDS segment, any way you can quantify the weakness in California for us? And in order to help us to better understand, if we've hit that inflection point of kind of the negative turning to a positive as it relates to Southern California?

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Tyrone Johnson, Select Interior Concepts, Inc. - CEO & Director [9]

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Yes. In terms of trying to quantify it, here's what I will say. If you look at the NAHB data or Metrostudy or any of the sources that provide MSA level start activity, I think you could get a good feel for what folks are seeing in Southern California. What I can tell you is that our business is performing better than those published numbers. So from that standpoint, we feel like we're doing pretty well, given the slowdown in the marketplace.

And as it relates to kind of what I think the inflection point might be, what I can say is we're seeing a number of builders start to shift their mix, which is exciting, cultivate land, develop communities more inland, creating an opportunity for more start activities. And certainly, we'll benefit from that. So if the shift in mix and kind of the new product going up from builders is any indication of the market, then we're encouraged.

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Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [10]

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Nadeem, one for you, real quick. Any thoughts on how we should think about a target for cash flow from operations for 2019 or longer term as it relates to what this business can do?

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Nadeem Moiz, Select Interior Concepts, Inc. - CFO [11]

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Absolutely. Look, the free cash flow conversion in this business is about 9%. So that's historically what the business does. So that's a good metric to keep in mind. You can see the positive cash flow in the first 6 months that the business has generated, and we'll pick up the cash flow generation as we get into the latter part of the year. Given the seasonality of the business, the cash flow really comes in this business in really the fourth quarter, which is typical of businesses in the housing and building sector. So again, we've done about $9 million year-to-date cash flow from operations, and then you'll see that pick up in the second half of the year.

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Operator [12]

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(Operator Instructions) Our next question is from Matt McCall with Seaport Global Securities.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [13]

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So I want to go back to your top line outlook. I think, Nadeem, you gave it. You talked about the new construction environment, flattish, talked about R&R and share gains. I guess, the first part of the question, were you talking about your new construction business or you talking about starts, what are you referencing in terms of the new environment? And then if you roll all those up, what were you trying to tell us about the back half growth expectations?

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Nadeem Moiz, Select Interior Concepts, Inc. - CFO [14]

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Yes, absolutely, Matt. So with respect to the general comment, it is -- it references sort of national activity that we see based on various sources that we look at, including NAHB and number of other data points. So that's a national reflection. Certainly, as it pertains to us, how it translates to us is we've got advantages with respect to being in geographies that are doing better than national average. That's point number one. Number two, we have an ability to cross-sell and improve our growth rate, given the acquisitions we've done in specific markets that are growing better and our ability to introduce new products. And then the aspect of repair and remodel, which is roughly half of ASG. So all those 3 things when you take that into consideration, we are very confident that we can do better than the national market. So -- and if you dive deeper, the analysis really we do internally is at a market-to-market level. But as an overarching view, our view is the national market is flattish this year and our ability to perform vis-à-vis that market is strong.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [15]

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Okay. Okay. I think -- Ty, I think you mentioned builders looking at entry level, small -- midsize homes. What does that transition or progression mean to your ability to upgrade and upsell? I assume there's not as many upgrades and upsells, or is that a poor assumption?

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Tyrone Johnson, Select Interior Concepts, Inc. - CEO & Director [16]

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No, I think that's the right assumption, Matt. There's not as many per house. The houses are typically smaller. So you don't have as many. You're also probably not going to realize the total dollars that you would at a larger home. But what you do see is more velocity, more volume. We'll actually perform more installations. So the team is ready for the shift to higher velocity, more turns, to some extent making up for kind of the lower sales per home. And that's the dynamic we've seen in the past and that's what we expect to see moving forward.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [17]

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Okay. Okay. I wanted to go back to the tariff question. I think the answer was mostly focused on ASG and quartz. What about RDS? I know I think there's -- maybe the latest round of tariffs mentioned cabinets. Can you just talk about the RDS business and any type of tariff risk and/or benefit?

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Tyrone Johnson, Select Interior Concepts, Inc. - CEO & Director [18]

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Yes. So with respect to cabinets and other products that may be purchased by RDS, sitting here today, we haven't felt much, if any, impact from that now. I'm very much aware of some of the news that's out there. Remember, Matt, in the RDS business, we have the ability to take price up real time. And should there be some inflation in that regard, we'll pass that on immediately. We're obviously relying on our partners to abate that to the extent they can, delay that to the extent that they can, and we could always look at additional sources of supply. But should an increase come through, we feel very confident in our ability to pass that on and not absorb any of it.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [19]

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Okay. Okay. And then the last one. You said the quarter, Nadeem, was in line with your expectations. I guess, if you think about going into the quarter and then exiting the quarter, in total, it sounds like kind of in line with what you expected. But going maybe a little deeper into the results, were there anything -- any items, line items or any trends that surprised you to the positive or surprised you to the negative?

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Nadeem Moiz, Select Interior Concepts, Inc. - CFO [20]

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No, not really. I mean, it's pretty much in line. We had a pretty good view going into the year on some of the softness in volumes in certain geographies. Hence, the diversification strategy that we really have been working on for about a year now and it's starting to pay dividends. And then also the greenfield sites in ASG, right? So we had a pretty good view on that.

And if you look at sequentially, which is another data point, I sort of pointed that in my script, you can see the sequential improvement in every metric. Sales, gross margin, EBITDA and adjusted EBITDA and adjusted EBITDA margin sequentially. And so that's very much in line with what we thought. And as you look into second half of the year, the seasonality in this business is definitely back-end loaded, second half of the year, given the construction cycle. And so we feel very good about the second quarter, again, in line with our expectations. And given all the initiatives that we have underway with respect to top line growth, mix enhancement, gross margin enhancement and really getting operating leverage as you get into sort of the busier season, if you will, we remain excited about the second half.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [21]

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And I want to sneak one that reminded me. The cross-selling opportunities and the efforts to cross-sell some of these new products in some of these new markets, is it progressing as expected? Is it ahead of plan? I'm just curious about what you've learned thus far with some of these new assets.

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Nadeem Moiz, Select Interior Concepts, Inc. - CFO [22]

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Yes, absolutely. Look, we've got just a great response from our customers on their cross-sell opportunities. And part of this has been in the works over the last couple of years as we've expanded into new geographies through acquisitions. And in the past that was a bit of hurdle. We weren't in certain markets, and our customers, in particular, the national homebuilders are national. And so what this has allowed us to do is have a very meaningful conversation with our customers who are extremely excited to have us participate in bidding activity and other trades that we don't currently do in those markets as we've done those acquisitions, right? So we did an acquisition at the end of last year, T.A.C., in Virginia, Mid-Atlantic. Well, that business is predominantly a flooring business and the key customers are sort of the national builders and some of the larger regional builders and they've always wanted us to expand our capabilities in other markets, and this gives us a perfect platform. So what I would tell you is we're a meaningful bidding process there. It gives us a lot of confidence in our backlog view. And we feel really good about those geographies and our ability to cross-sell into markets and trades that are our core competencies. So this -- in that case, it's going to be cabinets and countertops, which we've done a great job in establishing ourself in terms of service and craftmanship and other geographies that we service the same builders today.

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Tyrone Johnson, Select Interior Concepts, Inc. - CEO & Director [23]

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Yes. And this is Ty, Matt, just to kind of add on to that briefly. Look, I'd be remiss not to shout out Kendall and his team at RDS for really driving this. The cultural issues of surrounding acquisitions aren't necessarily easy to resolve. And even when you resolve them, it doesn't happen quickly. They've just done an enormous job of getting people on the same page with respect to cross-selling and being one company. And as a result, we're pleased with our performance, and I would dare saying we're ahead of schedule in some cases. So just wanted to make sure that we acknowledge the team that's out there actually doing this.

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Operator [24]

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There are no further questions registered at this time. This concludes the question-and-answer session. I would like to turn the conference back over to Ty Johnson for any closing remarks.

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Tyrone Johnson, Select Interior Concepts, Inc. - CEO & Director [25]

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Great. Well, thank you, everyone, for joining us today. We appreciate your support of SIC and look forward to updating you on our progress next quarter. Thank you.

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Operator [26]

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This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.