Hillman Solutions Corp. (NASDAQ:HLMN) Q1 2023 Earnings Call Transcript May 13, 2023

Operator: Good morning and welcome to the First Quarter 2023 Results Presentation for Hillman Solutions Corp. My name is Amber and I will be your conference call operator today. Before we begin, I’d like to remind our listeners that today’s presentation is being recorded and simultaneously webcast. The company’s earnings release, presentation and 10-Q were issued this morning. These documents and a replay of today’s presentation can be accessed on Hillman’s Investor Relations website at ir.hillmangroup.com. I’d now like to turn the call over to Michael Koehler with Hillman.

Michael Koehler: Thank you, Amber. Good morning everyone and thank you for joining us. I am Michael Koehler, Vice President of Investor Relations and Treasury. Joining me on today’s call are Doug Cahill, our Chairman, President and Chief Executive Officer and Rocky Kraft, our Chief Financial Officer. We will begin today’s call with a business update and quarterly highlights from Doug, followed by a financial review of the quarter from Rocky. Before we begin, I would like to remind our audience that certain statements made on today’s call may be considered forward-looking and are subject to the Safe-Harbor provisions of applicable securities laws. These forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties, assumptions and other factors, many of which are beyond the company’s control and may cause actual results to differ materially from those projected in such statements.

Some of the factors that could influence our results are contained in our periodic and annual reports filed with the SEC. For more information regarding these risks and uncertainties, please see Slide 2 on our earnings call slide presentation, which is available on our website ir.hillmangroup.com. In addition on today’s call, we will refer to certain non-GAAP financial measures. Information regarding our use of and reconciliations of these measures to our GAAP results are available in our earnings call slide presentation. With that, it’s my pleasure to turn the call over to our Chairman, President and CEO, Doug Cahill. Doug?

Douglas Cahill: Thanks, Michael. Good morning, everyone. Today, I’m going to touch on a few highlights for the quarter, provide a quick overview of Hillman, then discuss the current environment before I turn it over to Rocky to talk numbers. First off I want to say how pleased I am with our Hillman team has executed so far this year, in a dynamic operating environment. Our results for the quarter illustrate our strong performance. Net sales in the first quarter of 2023 were $349.7 million. When backing out COVID related sales last year, our first quarter 2023 sales were essentially flat versus the first quarter of 2022. Adjusted EBITDA in the quarter totaled $40.2 million. We feel good about these results considering the high cost of goods still flowing through our income statement, resulting from the record-high container cost from last summer.

Free cash flow in the quarter totaled $13.4 million and allowed us to pay down debt during the quarter. This is noteworthy as we usually see our debt increase during the first quarter as we borrow for our spring build. Now let me frame our results for the quarter and add a little context. Top line was consistent with our expectations in spite of the weather. We’re pleased with our adjusted EBITDA results even with the inventory cost at an all-time high. And lastly, our free cash flow exceeded our expectations for the quarter. Because of this, we are reiterating our full-year guidance across all three metrics. We maintain our belief that during 2023 our net sales will be between $1.45 billion and $1.55 billion. Our adjusted EBITDA will be between $215 million and $235 million and our free cash flow will be between $125 million and $145 million.

We still believe 2023 will be the tale of two halves. Our expectations are unchanged from our last earnings call. We expect first half adjusted EBITDA to be down high single-digits versus last year and the second-half adjusted EBITDA to be up just over 20% versus last year. We’re in a great position with our customers and our suppliers, our moat, which I’ll touch on in a moment is growing wider and deeper and our end-markets which are repair, remodel and maintenance are healthy and resilient. The Hillman team is executing well. We believe we are the best partner for fasteners and other hardware solutions in North-America. For those that are new to the Hillman story, we’re one of the largest providers of hardware products and solutions to hardware stores, home improvement centers and other big-box retailers throughout North America.

Our products are used by pickup truck pros and DIYers on repair, remodel and maintenance projects. We were founded in 1964 and we have a remarkable track-record, having grown our top line in 58 years of 59 years. Our record has been driven by the resiliency of the repair, remodel and maintenance markets that we serve, our competitive moat, which consist of three main differentiators, one, our in-store sales and service team. This group consist of 1,100 associates that deliver best-in-class service and industry leading fill rates to our customers at the shelf. Two, we ship our products directly to our customers, retail locations. Our team distributes over 112,000 SKUs to over 40,000 locations. In total, approximately 80% of our shipments are delivered directly to the store.

And three, importantly, 90% of our revenue comes from brands that we own, maintaining control over innovation, marketing and distribution allows us to quickly adapt to the ever-changing needs of our customers and our end-users. We help customers overcome labor, complexity and supply chain challenges and these all important high-margin traffic generating product categories, so that when the pickup truck pro or the DIYer gets to the shelf, the experience in the store is better when team Hillman is your supplier. Let me give you a quick example of why our moat is so wide and deep and why our relationships are truly embedded with our customers. Unfortunately, three weeks ago in Shawnee, Oklahoma, tornado touchdown causing significant damage to the community.

The local Lowes roof was damaged, which prevented customers from accessing the fastener isle at a critical time for our products. The Hillman team sprung into action with Lowes and set-up a pop-up fastener section where we were able to get product ordered, picked, shipped and delivered from the warehouse straight to the store within 12 hours. This allowed the local Lowes store to take care of their Shawnee customers and help them begin to repair and rebuild their community. Service like this is why we have 20 plus year relationships with all five of our top customers. When you consistently and reliably bring your customers something that competitors can’t, the result is a longstanding, growing partnership. Now let me move to our results for the quarter.

As I mentioned earlier, our total Q1 2023 net sales excluding COVID were flat versus 2022, reflecting a 4% decline in volumes and a 1% headwind from unfavorable FX in our Canadian business. This was offset by a 5% lift from price increases executed during 2022. Lighter volumes were driven by a 13% decline in foot traffic at-home improvement centers versus 2022, weather in the West as you have already heard was also a headwind. Our top line results in-spite of the foot traffic declines continue to illustrate the resilient demand driven by repair, remodel and maintenance projects. Now let’s breakdown the net sales by business. A hardware solution is our biggest business and makes up over 50% of our overall revenue. For the quarter, HS led the way with an 8% increase in revenue compared to last year.

The increase breaks down to approximately 6% in price plus just under 2% in volume, which was driven by new business wins in the last 12 months. While hardware volumes were up low to mid-single-digits during the first half of the quarter, the latter half slowed due to record rainfall particularly out west. As a result, we assumed there would be some pent-up demand out West and that appears to be true looking at sales over the past six-weeks out there. Robotics & Digital solutions or RDS make-up about 20% of our overall revenue. During the quarter, RDS revenues were up slightly over Q1 of 2022, driven by an increase in sales from our self-serve key duplication machines, MinuteKey, which was offset by lighter sales in the other RDS categories like padding graving and accessories.

RDS is a key driver of highly profitable long-term growth. As we talked about in the past calls, 2023 is a transition year for the RDS, as we invest in our growth. This year, we expect year-over-year top line growth in the mid-single-digits and an attractive adjusted EBITDA margin profile of around 32%. As we look-forward, we believe 2023 will set the stage for new accelerated profitable growth in RDS during 2024, driven by investments in the enhanced quick take three padding graving machines, our next-generation MinuteKey 3.5 key duplication machines and our Resharp knife sharpening machines. Rocky will shed more light on these three in just a minute. Our Canadian segment which makes up about 10% of our overall revenue decreased 5.1% compared to a year-ago quarter.

Volumes in Canada came in about where we expected, up a little over 1%, which was more than offset by six points of negative FX headwinds during the quarter. Lastly, our Protective Solutions business makes up just under 20% of our business, excluding COVID related revenue from 2022, Protective revenues were down 21.1% compared to prior year quarters. Lighter foot traffic, the West Coast weather and timing of promotional activities hurt us in the quarter. Despite PS’ slow start to the year, we have all of our promotional activity locked in for the remainder of the year. We will launch our AWP brand through our traditional hardware channel in Q2 and a new piece of business with one of our top five customers will launch during Q4. As a result, we feel good about 2023 being up low-single digits, excluding COVID.

Our PS product offerings continue to push the envelope for innovation and performance. Recently, Better Homes & Garden tested 17 of the top gardening gloves on the market over a six-month time frame. The result was that our firm grip branded gloves won best overall glove. A regular topic of discussion with our investors has been our inventory, as lead times to major started to increase in 2021, we made the strategic decision to invest in inventory in order to protect fill rates and ensure we took great care of our customers. The result of this is twofold; first, we took great care of our customers. Our fill rates averaged more than 90% during 2021, 96% during 2022 and 97% on average for the first quarter of 2023. The second result is that we sell our inventory on-hand increased throughout 2021 and peaked during the summer of 2022, with about a $180 million more than we would have on-hand in normal times.

Since that peak inventories have been reduced by $124 million, including a $38 million reduction during the first quarter. At quarter-end, we were still carrying nearly $60 million of inventory more than normal. We believe it’s realistic that we’ll reduce inventory by an additional $35 million or a total of approximately $75 million for 2023. This is above our original expectation of $50 million. This will put us near our normalized inventory run-rate at the end of the year and I have to say I’m really proud of how our global supply chain team has performed, flashing inventories both up and down with over 100,000 [Indiscernible] fill rates. The inventory reduction enhances our free cash flow, which we will use to pay down debt. It is our expectation that we’ll generate free cash flow and reduce our debt throughout the year, which Rocky will touch on shortly.

Now turning to price and cost. Since inflation started to rear its ugly head in 2020, we’ve seen $225 million of cost inflation, which we have passed on to our customers on a dollar-for-dollar basis through multiple price increases, the last of which went into effect in the fall of 2022. These cost break down to approximately $120 million of transportation and shipping costs, $90 million of commodities and $15 million of labor. Over the past several months, we’ve seen some of these costs come down and effective May 1, 2023, we secured our annual ocean container contracts at attractive rates, which will be a tailwind for us in 2024. While we are pleased with this, many costs still remain impacted by inflation like steel, labor and outbound freight.

Our cost of goods sold for the quarter were some of the highest we have seen in the history of the company, the sequential 190 basis point reduction in gross margin percentage illustrates the impact in placing had on our results for the quarter, because of how inventories flow through our income statement, our cost of goods sold for February and March included the high container costs we paid during the summer of last year. While these costs have fallen dramatically, they must work through inventory first before we see the benefit. When it comes to costs that we can control, I’m pleased with how the team has executed. For example, our new Kansas City distribution hub is open and operating and will fully replace our Rialto, California distribution hub by the end of the second quarter.

We avoided a multi-million dollar cost increase by moving the facility to Kansas City and this move will result in long-term network efficiencies. Over the past several years, we have invested in our North American distribution network, having opened new distribution facilities near Jonestown, Pennsylvania; Shannon, Georgia, which is north of Atlanta and in Greater Toronto. This new infrastructure allows us to serve our customers in an efficient and effective manner, illustrated by our 97% fill rates for the first quarter, provides us also efficiencies as we enhance our direct store delivery capability. As I’ve discussed, starting in the second half of the year, our business is set to benefit from several solid tailwinds. These coupled with our organic growth plans and market share gains, improvements in our inventory and leverage and the consistent performance of this company throughout all economic cycles will allude to an even more exciting future for Hillman.

With that, let me turn it over to Rocky.

Robert Kraft: Thanks, Doug and good morning, everyone. Net sales in the first quarter of 2023 were $349.7 million, a decrease of 3.7% versus the prior year quarter. When backing out COVID related sales from the first quarter of 2022, sales were essentially flat. Considering pent-up demand in West due to weather, our back-half loaded calendar for PS and some new business in PS and HS coming online in the second half of the year, we feel very comfortable reiterating our original top line guidance. The midpoint of our net sales guide assumes volume on existing products declined 1%. We benefit 2% from price that will roll from 2022 and new business wins offset last year’s COVID-related sales. Now let me provide some more detail on our top line by business.

Hardware Solutions was our best-performing business during the quarter. Net sales increased 8% to $205 million. The improvement was driven by 6% of realized price increases that were implemented over the past 12 months and a volume increase of just under 2%. RDS net sales were up slightly to $61.1 million as foot traffic and discretionary spending offset a strong lift in sales at our MinuteKey self-service key duplication machines. We believe 2023 is a transition year for RDS, as we have some exciting opportunities for 2024 and beyond that we are working on. We continue to work with our major key duplication and engraving customers to perfect our MinuteKey 3.5 next-generation digital kiosk. This new self-service kiosk will duplicate not only home and office keys, but also auto keys and smart auto costs, as well as RFID key cards and fobs.

We believe this will be ready for the market late this year and into early 2024. Quick Tag 3.0 is our new engraving machine that is being introduced throughout 2023. We plan to place around 700 new machines this year, which is down slightly from our original expectations of 800. These placements will match the pace of our mass retail partners renovation plans. We remain very excited about this new machine and expect to see a lift in both units and revenue per day on Quick Tag 3.0 versus the legacy Quick Tag machine. Regarding our one-of-a-kind knife sharpening machine Resharp, we have approximately 1,000 machines of select a hardware source across the country and have been working to optimize the marketing economics and location of each machine.

Outside of hardware, we’re testing Resharp in new channels like specialty retailers, food service and restaurant supply stores and outdoor and recreational retailers. We are currently having on-going dialogue with multiple stores about Resharp and remain very optimistic about its potential. Our Canadian business saw net sales down 5.1% compared to the prior year. However, volumes were up and considering the weather in Canada so far this year, we are pleased with those results. FX dragged down our top line and profitability. For the year, we continue to think that we will get our adjusted EBITDA margin goal of 10% for Canada. For the quarter, Protective Solutions revenues were up $26.4 million, of which $13.4 million related to 2022 COVID PPE sales.

Doug mentioned some of the other headwinds PS had during the quarter earlier, but we are expecting a solid second half for PS and that the business will grow low single digits over 2022 when excluding COVID-related sales. Adjusted earnings per diluted share for the first quarter of 2023 was $0.06 per share compared to $0.09 per diluted share in the prior year quarter. First quarter adjusted gross profit margin improved by 30 basis points to 41.5% versus the prior year quarter as we were still chasing costs last year. Sequentially, margins were 190 basis points lower than last quarter due to the higher cost of goods sold now flowing through our income statement. That said, we expect to see margins expand sequentially by more than 100 basis points next quarter, then during the second half of 2023 we anticipate margins in excess of our historical rate of 44% to 45%.

The result will be a 20% plus increase in adjusted EBITDA during the second half of 2023 versus the second half of 2022. Q1 2023 adjusted SG&A as a percentage of sales increased to 30.3% from 29.4% from the year ago quarter. This analysis backs out stock compensation, acquisition and integration expenses, certain legal fees and restructuring costs, which we feel gives us a better analysis of our base expenses. At a high level, increases were driven by revenue sharing arrangements in RDS due to outsized growth in our kiosk business and inflation related to outbound freight and labor. Adjusted EBITDA in the first quarter was $40.2 million compared to $44 million in the year ago quarter. Adjusted EBITDA reflected higher cost of goods sold coupled with the decline in net sales.

As we think about the opportunities that lie ahead for the remainder of the year, we feel very comfortable reiterating our original adjusted EBITDA guidance. Now turning to our cash flow and balance sheet. For the first quarter of 2023, operating activities provided $32 million of cash as compared to a $4 million used in the prior year quarter. Capital expenditures were $18.1 million compared to $12.5 million in the prior year quarter. We continue to invest in our RDS equipment and merchandising racks, important parts of our high-return CapEx initiatives. Net inventories were $450.9 million, down $38 million sequentially from $489.3 million last quarter. We ended the first quarter of 2023 with $876.9 million of total net debt outstanding, down $11 million from the $887.7 million at the end of 2022.

Free cash flow for the quarter totaled $13.4 million compared to a cash burn of $16.1 million in the prior year quarter. Further, over the last three years, our net debt has increased by an average of $35 million during the first quarter and for Q1 of this year, it decreased by $11 million. This positive swing was driven by converting our prior investments in inventory to cash. Similar to our net sales and adjusted EBITDA, we feel very comfortable reiterating our original free cash flow guidance. We ended the first quarter of 2023 with approximately $244 million of liquidity, which consist of $209 million availability to borrow under our revolving credit facility and $35 million of cash and cash equivalents. Our net debt to trailing 12-month adjusted EBITDA ratio at the end of the quarter was 4.2 times, consistent with the end of 2022, which was a strong achievement for the first quarter, given typically experiences a seasonal uptick in leverage in the first quarter.

Looking forward, we expect to end 2023 under 3.5 times and that assumes we come in near the midpoint of our guidance. The majority of the de-levering will occur in the second half of the year as margins expand and we use our free cash flow to pay down our ABL revolver and term note. As we look further out, our long-term growth target of 6% organic net sales and high single to low double-digit organic adjusted EBITDA growth before M&A remains intact. From a leverage standpoint, our goal is to run the business below 3 times. With that, I’ll turn it back to Doug.

Douglas Cahill: Thanks, Rocky. As I’ve expressed today, I’m very confident about our business heading into the remainder of 2023 and 2024. We continue to stay humble and take great care of our customers. Our differentiated business model with 1,100 field sales and service folks combined with our direct-to-store delivery model creates tremendous value for our customers, value that we think they recognize. We know the opportunity that is ahead of us and we’ve got a great team excited to capitalize on that, which we believe will drive long-term growth and meaningful value for all of our stakeholders. With that, we’ll begin the Q&A portion of the call. Amber, can you please open up the call for questions? Amber, can you please open up the call for questions.

Q&A Session

Operator: Certainly. [Operator Instructions] Our first question comes from the line of Lee Jagoda from CJS Securities. Please ask your question, Lee.

Operator: Thank you. Our next question comes from the line of Michael Hoffman from Stifel. Please ask your question, Michael.

Operator: Thank you. Our next question comes from the line of Dave Manthey from Baird. Please ask your question, Dave.

Operator: Thank you. Our next question comes from the line of Stephen Volkmann from Jefferies. Please proceed with your question, Stephen.

Operator: Thank you. Our next question comes from the line of Matthew Bouley from Barclays. Please ask your question Matthew.

Operator: Thank you. Our next question comes from the line of Reuben Garner from Benchmark. Please ask your question Reuben.

Operator: Thank you. This concludes the Q&A portion of today’s call. Thank you very much for all your questions. I would like to turn the call back to Mr. Cahill for some closing comments.

Douglas Cahill: Thanks, Amber. Thanks, everyone for joining us this morning and also I’d like to thank our suppliers and our vendors and our customers and importantly, our hard-working team at Hillman for their contributions though the quarter. We look forward to updating you again in the near future and thanks a lot for joining us this morning.

Operator: This concludes today’s conference call. Thank you for participating. You may now disconnect.