Q2 2023 Griffon Corp Earnings Call
Participants
Brian G. Harris; Senior VP & CFO; Griffon Corporation
Ronald J. Kramer; Chairman of the Board & CEO; Griffon Corporation
Unidentified Company Representative
Noah Christopher Merkousko; Senior Research Associate; Stephens Inc., Research Division
Robert James Labick; President of Research & Managing Partner; CJS Securities, Inc.
Samuel John Darkatsh; MD & Research Analyst; Raymond James & Associates, Inc., Research Division
Timothy Ronald Wojs; Senior Research Analyst; Robert W. Baird & Co. Incorporated, Research Division
Presentation
Operator
Good morning, ladies and gentlemen, and welcome to the Griffon Corporation Fiscal Second Quarter of 2023 Earnings Conference Call. (Operator Instructions) This call is being recorded on Wednesday, May 3, 2023.
I would now like to turn the conference over to Mr. Brian Harris, Chief Financial Officer. Please go ahead, sir.
Brian G. Harris
Thank you, [Ines]. Good morning, everyone. With me on the call is Ron Kramer, our Chairman and Chief Executive Officer. Our call is being recorded and will be available for playback, the details of which are in our press release issued earlier today.
As in the past, our comments will include forward-looking statements about the company's performance based on our views of Griffon's businesses and the environments in which they operate. Such statements are subject to inherent risks and uncertainties that can change as the world changes. Please see the cautionary statements in today's press release and in our various Securities and Exchange Commission filings.
Finally, some of today's remarks will adjust for those items that affect comparability between reporting periods. These items are explained in our non-GAAP reconciliations included in our press release.
And now I'll turn the call over to Ron.
Ronald J. Kramer
Thanks, Brian. Good morning, everyone, and thanks for joining us. This is the first earnings call we've hosted since we initiated our strategic alternative review process, so we have a lot to discuss. Let me start by commenting on our strategic review process and its conclusion before reviewing our operating results, expectations for the year and go-forward strategy.
We publicly announced the commencement of this process in May of 2022, but actually, the process began even earlier in January of 2022 when we formed our Committee on Strategic Considerations and engaged our advisers, Goldman Sachs and Decker. The Committee on Strategic Considerations, which was comprised solely of independent members of our Board, was given the mandate to work with our advisers to evaluate a comprehensive range of strategic alternatives to maximize shareholder value, including a possible sale, merger, divestiture or recapitalization.
Over the remainder of 2022 and into 2023, Griffon and its advisers thoroughly explored many types of strategic alternatives and engaged with a wide variety of potential counterparties with the goal of finding strategic alternatives that would provide compelling value for Griffon's shareholders. After extensive review and deliberation, the Griffon Board unanimously concluded that none of these alternatives, which we explored, appropriately valued Griffon's strong operating performance and growth prospects.
And as a result, the Board unanimously determined that continuing to focus on executing our strategic plan is the best approach for maximizing shareholder value at this time. Our decision is a reflection of our Board's confidence in Griffon's outlook and strategy.
Due to the confidential nature of the process, we cannot disclose specific details regarding options explored or negotiations conducted. What I can tell you, however, is that the duration of this process over a year from initiation to conclusion is an indicator of how comprehensive the process was during the period of rapidly changing economic and financing conditions.
With the process now concluded, we continue to believe that there is a fundamental disconnect between our share price and the intrinsic value of our businesses, and we are committed to taking a series of actions to provide additional value to our shareholders. Further, I want to be clear that while we are no longer proactively exploring strategic alternatives, we will continue to be open to and will consider all opportunities to enhance shareholder value.
Let me turn to the operating results. Griffon's performance through the first half of 2023 has exceeded our expectations. Our results were driven by the performance of our Home and Building Products segment, HBP, which continued to see growth in commercial volume and favorable price and mix across all products and channels. Residential volume decreased year-over-year, what was better than expected.
The HBP team, led by Vic Weldon, has been able to address the sectional door backlog that built up over the past 2 years. The factory is now operating with normalized backlog and lead times. This is great news as it frees up the HBP team to focus its attention on further improving productivity. It also allows the team to expand business development efforts that were previously slowed down as a result of our larger backlog and longer lead times.
The team is now intensifying their efforts to capture additional residential and commercial business by expanding marketing efforts and leveraging our leading positions in sectional and rolling steel product offerings. These efforts are complemented by a portfolio of innovative product offerings that are being positively received by customers. I want to thank the HBP team for their extraordinary performance and ongoing commitment to building this fabulous business.
Performance of the Consumer and Professional Products business continues to reflect the difficult retail market conditions in which we are operating. All CPP channels and geographies are being affected by reduced consumer demand and elevated customer inventory levels.
This situation has been particularly challenging in the U.S. lawn and garden and storage and organizational markets, where we have seen customer supplier diversification drive shifts in buying decisions, which, in some instances, has exacerbated weakness in consumer demand. The combination of reduced volumes and unfavorable manufacturing and overhead absorption has impacted operating leverage to the point that some of CPP's U.S. product lines have become unprofitable.
To address these evolving market conditions, CPP is expanding its global sourcing strategy to include long-handled tools, material handling and wood storage and organization product lines that are currently manufactured in the United States for sale in the United States. The CPP team will leverage its extensive global sourcing experience and capability to effectively manage this transition by utilizing an asset-light structure. CPP's U.S. operations will be better positioned to serve customers with a more flexible and cost-effective global sourcing model, enabling it to manage costs and efficiently meet variable demand and to enhance future profitability.
These actions will enable CPP to continue providing high-quality products, leveraging our iconic brands while strengthening our competitive positioning with industry-leading distribution and service that our customers and consumers expect. In addition, these actions are a continuation of the evolution of CPP, positioning the segment to achieve targeted EBITDA margins of 15% and generating substantial additional value for our shareholders.
Let's turn to guidance for the year. Our overall strong performance in the first half has exceeded our expectation. As a result, we are raising our full year segment EBITDA guidance to at least $525 million from the previous guidance of $500 million. Also, earlier today, the Griffon Board announced a 25% increase to our regular quarterly dividend. This is in addition to the $2 per share special dividend and the increase in our share buyback authorization to $258 million that was approved by our Board 2 weeks ago.
These actions demonstrate our commitment to enhancing both immediate and long-term value to our shareholders and reflect the confidence Griffon's Board and management have in our strategic plan and outlook. Let me turn it over to Brian to go through some of the financials.
Brian G. Harris
Thank you, Ron. I'll start by discussing our second quarter consolidated continuing basis performance. Revenue of $711 million decreased by 9% and adjusted EBITDA before unallocated amounts of $152 million decreased by 1%, both in comparison to prior year quarter. Adjusted EBITDA margin was 21%, increasing approximately 180 basis points year-over-year.
Gross profit on a GAAP basis for the quarter was $194 million compared to $261 million in the prior year quarter. Excluding restructuring-related charges and the acquisition write-up of inventory, as applicable, from the current and prior periods, gross profit was $269 million in the current quarter, increasing 1% over the prior year quarter. Gross margin increased year-over-year by 375 basis points to 37.9%.
Second quarter GAAP selling, general and administrative expenses were $160 million compared to $150 million in the prior year. Excluding adjusted items from both periods, selling, general and administrative expenses were $150 million, representing 21.1% of revenue compared to the prior year of $144 million or 18.5% of revenue.
Second quarter GAAP loss from continuing operations was $62 million or $1.17 per share compared to the prior year period income of $58 million or $1.09 per share. This decline was primarily driven by charges related to CPP's intangible asset impairments and global sourcing expansion. Excluding all items that affect comparability from both periods, current quarter adjusted net income from continuing operations was $67 million or $1.21 per share compared to the prior year of $73 million or $1.36 per share.
In the quarter, we recorded a noncash impairment charge from indefinite-lived intangible assets of $100 million or $74 million net of tax. The charge is the result of CPP's year-to-date expected 2023 results being below expectations. Corporate and unallocated expenses, excluding depreciation, were $14.6 million in the quarter compared to $13.1 million in the prior year.
Our normalized effective tax rate, excluding adjusted items for the quarter, were 29.5% and 29.4% for the year-to-date period. Capital spending was $7.1 million in the second quarter compared to $11.5 million in the prior year quarter. Depreciation and amortization totaled $17.3 million for the second quarter compared to $16.3 million in the prior year.
Regarding our segment performance, revenue for Consumer and Professional Products decreased 24% from the prior year with organic revenue decreasing 29%. The reduction in revenue is primarily attributable to reduced volume across all channels and geographies, driven by soft consumer demand and elevated customer inventory levels.
These items were partially offset by a full quarter of Hunter revenue as well as favorable price and mix. CPP adjusted EBITDA decreased from the prior year by 59%, primarily due to the unfavorable impact of reduced volume and revenue and its related impact on manufacturing and overhead absorption. These items were partially offset by reduced discretionary spending and a full quarter of Hunter contribution.
Home and Building Products revenue increased 8% over the prior year quarter, driven by favorable pricing and mix for both commercial and residential products. Total volume decreased due to decreased residential volume, partially offset by increased commercial volume. Adjusted EBITDA increased 26% compared to the prior year quarter, driven by increased revenue and reduced material costs, partially offset by increased costs for labor, transportation, advertising and marketing.
As mentioned earlier and detailed in our press release, CPP is expanding its global sourcing strategy for products manufactured and sold in the U.S. The project includes the closure of 4 manufacturing facilities and 4 wood mills. We expect to complete this project by the end of calendar 2024.
In that period, we'll include incurred charges of $120 million to $130 million, including $50 million to $55 million of cash charges for employee retention, severance, operational transition and facility costs and $70 million to $75 million of noncash charges, primarily related to asset write-downs. We also expect capital expenditures in the range of $3 million to $5 million.
These charges exclude the benefit of cash proceeds from sale of owned real estate and equipment, which are expected to largely offset the cash charges and also excluding efficiencies due to duplicative labor costs and absorption impacts during transition. In both the quarter and 6 months ended March 31, 2023, CPP incurred pretax charges of $78.3 million related to the expansion of global sourcing strategy, consisting of cash charges of $19.2 million and noncash asset-related charges of $59.1 million.
Regarding our balance sheet and liquidity, as of March 31, 2023, we had net debt of $1.3 billion and net debt-to-EBITDA leverage of 2.5x as calculated based on our debt covenants compared to $1.4 billion of net debt and 2.7x leverage in the previous quarter. Regarding our 2023 guidance, we are updating our expectations for revenue and segment adjusted EBITDA. We now expect 2023 revenue of $2.7 billion compared to previous guidance of $2.95 billion as a result of decreased CPP revenue, partially offset by increased HBP revenue.
Adjusted EBITDA in 2023 is now expected to be at least $525 million compared to our previous estimate of at least $500 million. Our EBITDA guidance excludes unallocated costs of $56 million and charges related to the strategic review process of $22 million, which is an increase from our prior guidance of $16 million, as well as CPP's global sourcing expansion charges.
Our increased adjusted EBITDA expectations reflect strong HBP results, partially offset by the reduced CPP volume mentioned earlier. Guidance for other metrics remain unchanged for 2023, including free cash flow to exceed net income, capital expenditures of $50 million, depreciation of $50 million and amortization of $22 million, interest expense of $103 million and normalized tax rate approximating 29%.
As Ron mentioned earlier, Griffon's Board of Directors authorized a 25% increase to our quarterly dividend to $0.125 per share, payable on June 15, 2023, to shareholders of record as of May 25. On April 20, the Griffon Board approved an increase to our share repurchase authorization of $200 million, bringing the total outstanding authorization to $258 million.
Now I'll turn the call back over to Ron.
Ronald J. Kramer
Thanks, Brian. I want to highlight that despite our businesses continuing to navigate in an uncertain global macroeconomic environment, our employees have maintained high levels of customer service and product quality. We thank each of them for their efforts.
We are very confident about our future. Home and Building Products continues to perform well. And with HBP's return to normal operations after the pandemic surge, the business is now able to focus on growth and productivity initiatives. We continue to see long-term tailwinds for the business, driven by healthy demand for our commercial products and the historically resilient repair and remodeling market for our residential products.
We are also confident about the prospects for our Consumer and Professional Products segment. While CPP is currently working through challenging conditions, we expect the business environment will stabilize over time, allowing CPP to deliver significantly improved financial results.
Griffon's Board and management has strong conviction in our outlook and strategic plan, as demonstrated by the significant increase in our dividends and expanded stock buyback authorization. We will continue to use the strong operating performance of our business and its free cash flow to deliver long-term value to our shareholders. We believe our best days are ahead of us.
Operator, we'll take any questions.
Question and Answer Session
Operator
(Operator Instructions) The first question comes from Bob Labick with CJS Securities.
Robert James Labick
Congratulations on continued strong performance. Obviously, so many questions. I'll follow the instructions and ask to keep it brief and get back in queue.
But maybe starting with HBP. Obviously, the performance has just been off the charts and hard to model in a good way. Clearly, margins have improved materially from mix, pricing and operating efficiencies that you've garnered over the last year plus.
Can you give us a sense of maybe what's the new normal range for door's operating margins looking out? And how we can think about -- has there been like a overbuild period, where we are in the demand cycle? And what are normalized margins over the next few years for this business?
Ronald J. Kramer
Let me start by saying that building the company gets lost in moments in time. And you have to go back and recognize that we have been on a 5-year journey of building the Clopay business. We bought CornellCookson going on 5 years ago. We had 3 years of COVID. The -- we were doing well pre-COVID. We had a plan of improving margins that was working. We've come out of COVID. We have grown our commercial business. Our team has done an extraordinary job of managing the integration of the acquisition, the expansion of our commercial business to balance the already leading residential business that we have. We are positioned for residential and commercial growth. Our business is not dependent on new home construction.
It is a repair and remodel on the residential side, new home construction, which continues to be in a shortage in this country will only benefit us. The commercial business has grown, will continue to grow. And while this quarter is clearly the best margin quarter that we've ever had in HBP, we continue to see strength and sustainability of the business where that will shake out in terms of margin. Only time will tell, but we have a business that finished last year with $412 million of EBITDA, we'll be better than that this year. That's why we have confidence in raising our guidance and we believe the sustainability and the resilience of the business going forward that this is a defendable business with higher margins than we've enjoyed over prior cycles. Brian, do you want to add to that?
Brian G. Harris
I think you summarized it pretty well. unless Bob, you have an additional question to way.
Robert James Labick
Oh, no, that's -- I think that's super helpful there. Maybe just -- because I do appreciate the taking a step back. And obviously, we've been watching this journey since CornellCookson and any integration any expansion and everything. So maybe give us a sense of the commercial market opportunity and where you've been growing and where you're targeting additional growth in commercial now that you're kind of fully integrated and ready to go after it.
Brian G. Harris
Sure. I'll start. The commercial market has been strong. We continue to see good results from that side of the market from our historical legacy products as well as the new products that we've come up with over the last couple of years. In addition to that, we are getting great benefits out of leveraging the historical or the legacy CornellCookson dealers and bringing on our sectional commercial product into those dealers, and there's still much of that to capture in the future. Some of that was on pause over the last 2 years as our backlog was elevated. And now that our backlog and our lead times are normalized, we are going to be back out there and getting after that business. Of course, things like warehouse space, institutional type operations is where we see most of our business
Operator
Your next question comes from Tim Wojs with Baird.
Timothy Ronald Wojs
Maybe just the first one on maybe CPP. Is there a way just to maybe level set us in terms of kind of where that business after all the changes kind of lands from a revenue perspective on a normalized basis?
Brian G. Harris
Sure. So as we go through this process and come out the other side at the end of '24, we see this as a $1 billion-plus size revenue business that will be generating 15% level margins.
Timothy Ronald Wojs
Okay. Okay. Good. And then maybe just on the cash flow, kind of a 2-parter. I guess, first, like cash flow is supposed to be better than net income, but it's already kind of meaningfully better this year. So I guess is it possible that it's pretty meaningfully higher relative to net income? And then I guess where the stock is today? I mean, how aggressive would you be with the stock here just given the expanded buyback?
Brian G. Harris
Sure. Let me start by answering the cash flow question. Yes, we are seeing very good cash flow, especially in the first half of the year, where generally, we don't have much cash flow in the first half of the year. So it can be meaningfully better than net income, as you pointed out. But we stick with our stated better than net income, which falls under that category.
Ronald J. Kramer
And let me just add -- start with our balance sheet. We don't have a debt maturity until '28 and we have substantial free cash flow. We've authorized $258 million. Stay tuned.
Operator
Thank you. Your next question comes from Noah Merkousko with Stephens.
Noah Christopher Merkousko
First, I wanted to talk on HPP kind of just get an update on how you're seeing demand at least through the balance of the year, especially now that backlogs are normalized, I'd imagine that would limit your visibility somewhat. So I guess, how do you get confidence in the demand there for commercial and res R&R?
Brian G. Harris
Sure. On the residential side, volume is below what we've seen it last year, but it's in the resilient repair and remodel market. And actually, the volume has been a little better than we originally expected and leads to us raises in our guidance. On the commercial side, we continue to see strong volume. Our products are doing well, and I referenced back to us going after commercial sectional business, leveraging our legacy CornellCookson relationships.
Ronald J. Kramer
And the other point I'll make is, and our pricing has, and we expect it to continue to hold.
Noah Christopher Merkousko
Got it. That's really helpful. And then maybe switching gears to the CPP side. You've announced that you're expanding your global sourcing strategy, and we should expect 15% EBITDA margins in '24. But at what point...
Brian G. Harris
25%.
Noah Christopher Merkousko
Okay, 25%. At what point would you expect the strategy to start bearing fruit or start becoming accretive to segment margins?
Brian G. Harris
Yes. So '24 will remain a transitional period as we move over these particular product lines to a sourcing model. And those benefits will come through in '25. We expect it to take until roughly the end of calendar '24.
Operator
[Operator Instruction] Your next question comes from Sam Darkatsh with Raymond James.
Samuel John Darkatsh
It's good to hear your voices certainly on a formal basis. So a couple of questions, and I actually have 3 or 4, maybe I'll get back into the queue if possible. So the $250 million authorization, if you do it at least by my math, on the open market, that could take years depending on the daily volume. Why wouldn't you consider a tender or an ASR to put that money at work while the stock is at current levels?
Ronald J. Kramer
We don't think it will take years, and we will consider any and all possibilities, but we're not able to be in the market until we put out our earnings, let 48 hours go by, and I believe that means starting on Friday, expect us to be in the market.
Samuel John Darkatsh
Got you. And then the retention payouts, Brian, do they continue? Or how are they going to be accounted for now that the strategic review process has concluded, at least for the time being?
Brian G. Harris
Yes. So we'll continue to call those amounts out as there are -- though they are over several years, they are a specific event. And those payments will continue each third quarter for this year, next year and the year after.
Operator
Thank you. There are no further questions at this time. Mr. Kramer back over to you.
Ronald J. Kramer
No, I think Sam has some more questions.
Samuel John Darkatsh
Can you hear me okay?
Brian G. Harris
Okay. Terrific. Sorry about that. My last question, again, getting back to the CPP sourcing, which is fascinating. So where specifically are you contemplating moving the sourcing from a geographic standpoint? Is that going to be kind of a sole contract OEM manufacturing setup like you have with Hunter? How do you manage risk with that type of setup. If you could help us put a little meat on the bone in terms of what the plans are at this point?
Ronald J. Kramer
Well, let me start by saying this is an evolution and a continuation of what we do globally. We have a global sourcing office in China. We have facilities that we already work with our Australian business is part of that global sourcing. Our U.K. business is part of global sourcing. The evolution of our U.S. operations and our aggressive approach to repositioning it based on what's changed in the consumer markets. You correctly point out our Hunter relationship, and that is a design in the United States and manufactured elsewhere for distribution in the United States. So I view what we're doing to our CPP business is an evolution of what we've done successfully at very attractive margins globally to be able to fix a business in the U.S. that has a very high manufacturing overhead that can't be supported other than being on an outsourced global sourcing model.
Brian G. Harris
Yes, I would just add to that, global sourcing truly means global sourcing. That includes sourcing in South and Central America, the U.S. as well as Asia. And it's not going to be sole sourced to one person or one entity. And in fact, using entities over against themselves in further periods will give us even more advantage.
Samuel John Darkatsh
Is there an issue around the potential for challenged lead times based on some of the seasonality of some of these products. I thought that was one of the primary reasons why there was an appeal to a North American production footprint, especially around long-handled tools, whereby you're able to have high fill rates during the heavy selling season. How has that impacted? I'm guessing you might move that type of production to Mexico? Or is that also contemplated in Asia? I'm just trying to get a sense of how to manage risk and especially knowing that you still may look to monetize the CPP business at some point, making it still palatable for a potential suitor?
Brian G. Harris
Sure. So you touched upon part of it, we'll be sourcing from possibly closer areas, such as Central America. And further, we'll leverage our distribution footprint and keep enough inventory on hand to ensure that we provide the same levels of service to our customers that we have been able to do in the past.
Samuel John Darkatsh
Got you. And then if I'm still on, okay, terrific. They didn't cut us off yet. All right. So...
Ronald J. Kramer
We've been silent for a while keep going.
Samuel John Darkatsh
It's terrific that you're able to speak publicly again. The -- after the repo authorization has been completed, what do you anticipate the debt leverage either at that point or optimally for the business?
Brian G. Harris
So it will depend on when those buybacks occur. But generally, we don't expect leverage to get much above 3x type of level as we'll be generating cash flow as we're buying shares.
Ronald J. Kramer
And as we continue to generate cash, we're in a luxurious balance sheet position. We've got both undrawn bank capital. We've got no debt maturity, as I said earlier, until '28. We've got free cash flow, and we've got a very undervalued stock that we have every intention of taking advantage of. We've always been in the acquisition business. We're going to be acquiring as much of us as we can with free cash flow for the foreseeable future.
Unidentified Company Representative
Okay. Well, thank you all. Look forward to speaking to you after our next quarter in early August.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.
