Hillman Solutions Corp. (NASDAQ:HLMN) Q1 2024 Earnings Call Transcript May 7, 2024
Hillman Solutions Corp. misses on earnings expectations. Reported EPS is $-0.00764 EPS, expectations were $0.08. Hillman Solutions Corp. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning, and welcome to the First Quarter 2024 Results Presentation for Hillman Solutions Corp. My name is Tanya, and I will be your conference call operator today. Before we begin, I would 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 Investors Relations website at ir.hillmangroup.com. I would now like to turn the conference over to Michael Koehler with Hillman. You may begin.
Michael Koehler: Thank you, Tanya. 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; Jon Michael Adinolfi, our Chief Operating Officer; and Rocky Kraft, our Chief Financial Officer. Before we begin today’s call, I would like to remind our audience that certain statements made may be considered forward looking and are subject to 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 in our earnings call slide presentation, which is available on our website. 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?
Doug Cahill: Thanks, Josh [ph]. Good morning, everyone. I’ll kick off today’s call going through some of the highlights of our strong first quarter, during which we celebrated Hillman’s 60th anniversary. After that, I will provide some additional color on what makes Hillman unique before I turn it over to our COO, Jon Michael Adinolfi, or JMA as we call him. JMA will provide an update on our operations, the Koch acquisition we closed in January, and the M&A landscape. Rocky will then finish up with our financial results for the quarter before we turn it back to the operator for the question-and-answer session. During the first quarter of 2024, growth in both our top and bottom line demonstrated the resilient and consistent nature of our business.
Our results were in line with our expectations for the quarter, which has resulted in us reiterating our annual guidance across all three metrics, net sales, adjusted EBITDA, and free cash flow. Net sales in the first quarter of 2024 increased slightly to $350.3 million from the year-ago quarter. Driving these results were the contribution of new business wins. The Koch acquisition was closed in January of this year. These were partially offset by the overall market and a 40 basis point headwind from price. Adjusted EBITDA increased 30% to $52.3 million compared to $40.2 million during the first quarter of 2023. Our adjusted EBITDA margins for the quarter improved by 340 basis points to 14.9%. Similar to what we saw during the fourth quarter of 2023, in the first quarter of 2024, we had a relatively flat top line, but generated healthy bottom line expansion.
Adjusted gross margins totaled 47.6%, marking a 610 basis point improvement over the 41.5% during the year-ago quarter. Free cash flow came in consistent with our expectations as we used $6.1 million during the quarter. This was driven by our inventory build for our spring and summer busy season, as well as a $5 million use of cash to fund working capital related to the Koch acquisition. Let me frame the macro before we jump into our top-line results by segment. The macroeconomic landscape in the home improvement sector continues to show muted signs of improving. As we’ve all heard, inflation continues to hang around, which has prevented the Fed from cutting rates. The result is that mortgage rates have remained elevated. These higher rates are limiting existing home sales, which does impact our business, as homeowners are unwilling to trade out of a 3% mortgage rate into a 7% mortgage.
While pent-up demand for existing home sales continues to build, we agree with our customers. A strong increase in existing home sales is likely to happen when we start to see rates move downward. In the meantime, the Pick Up Truck Pro continues to be busy albeit, with smaller projects. And we did see the DIY is starts to get more active, as the weather improved throughout the quarter. That said, the overall market and foot traffic at our retailers were both negative compared to last year which fell in line with our expectations. Our retailers are cautiously optimistic for the second half of this year. And if they’re right we will be ready. But until then, we’ll continue to manage our cost structure and business for this environment. On top line results, Hardware and Protective Solutions or HPS led the way with a 2.4% increase in net sales.
To break that down a bit, Hardware or HS grew by 4.6%, while Protective or PS sales were down 6.9%. For the first quarter, PS net sales were impacted by the timing of our promotional off-shelf activity which will pick up, during the second quarter of 2024. PS had a solid year in 2023 and we expect a healthy 2024 for them as well. Driving the increase in HS, were new business wins and Rope & Chain accessories that we launched during the third quarter last year. We also benefited from nearly a full quarter worth of contribution from the Koch Acquisition which closed on January 11 2024. Speaking of the Koch Acquisition, which Jon will touch on more in a few minutes, our field sales and service teams are really excited to be selling the new product line which will drive additional growth in Hardware.
We’re working on some meaningful opportunities in this new Rope & Chain category that we and our customers are thrilled about. It fits Hillman perfectly. It’s an important product line for our customers. And it’s complex category to ship and keep organized at the shelf. During the quarter, net sales in our Robotics & Digital Solutions or RDS were down 9.2% to $55 million. Lighter foot traffic and discretionary spending coupled with existing home sales near a 30-year low weighed in on RDS during the quarter. As the consumer remains under pressure from inflation, our RDS business has been impacted more than our other businesses. Despite the softness in RDS, we remain optimistic about our long-term, high-margin growth opportunities which I’ll expand on in a moment.
Gross margin and EBITDA margins remain healthy at 71.6% and 30.7%, respectively. Last week we appointed Scott Moore, as our new divisional president of RDS. Scott was one of the early founding members of MinuteKey and join Hillman following its 2018 acquisition. Most recently Scott was our Chief Technology Officer will make a fantastic leader for RDS as we look to its next phase of growth with the rollout of MinuteKey 3.5. Scott and his team were instrumental in designing the software and technology that powers our MinuteKey platform and the new technology behind our MinuteKey 3.5 launch. The platform leverages Artificial Intelligence via Machine Learning to identify key tags use, using the state-of-the-art Visual Key Identification system.
Our machines are continuously gathering data, in order to read identify and execute factory original quality cuts which ultimately result in a great customer experience. Scott’s leadership discipline, in respect throughout the Hillman organization make him a great fit, for this role. Scott takes the reins from Randy Fagundo, who will retire following a long and successful career in the key as industry. Randy has been critical to the success of many key in RDS since joining Hillman, following the 2008 acquisition of MinuteKey. We are grateful for his meaningful contributions to Hillman. Randy, we’re going to miss you man, best of luck in your retirement. As we think about RDS, we are working on a number of growth initiatives. Scott was critical in developing our K2 Key as Technology Platform.
K2 provides software updates, that logging inventory management, pricing and promotions, data analytics and remote troubleshooting for the entire RDS kiosk fleet. Think of it as the eyes and ears inside the machine. We believe that our proprietary K2 Technology can add tremendous value with our vending and kiosk companies. And we are currently in discussions to license that technology. Another growth opportunity I’m excited about involves our RDS field service team. Today we have a dedicated group of mechanically skilled folks that service our fleet of kiosks, replenish inventories in the machine and keep the uptime at 98% for our entire fleet of kiosks. Recently two brand new customers selected Hillman to service their kiosks. For the first time, we will be servicing nine Hillman kiosk, these new accounts did their due diligence, driving along with our service reps talking to our customers in the analyzing what our K2 technology and our Tempe, Arizona plant could do for their businesses.
It’s no surprise they picked Hillman. This is another example of Hillman solving complex needs for customers in the store. These accounts will begin to add additional profitability to RDS in the second half of 2024. Lastly, as you all know, the most exciting growth opportunity lies in front of us with MinuteKey 3.5. Currently we have 101 machines in place in two test markets. These new kiosks offer home and office key duplication like our existing kiosks but additionally they have the ability to read and identify smart auto fobs, duplicate transponder and metal car keys as well as our FID fobs. We are building these machines with updated capability for three of the top customers and the initial feedback has been excellent. We expect to end 2024 with approximately 800 MinuteKey 3.5machines this year and the top retailers in America.
MinuteKey 3.5 will begin to contribute to our performance during the back half of 2024 and have a more sizable impact on our 2025 results. As the consumer with support from our retailers started to experience what a new MinuteKey kiosk can do for them. Heading north of the border, our Canadian business net sales were up slightly compared to prior year quarter. But team Canada had a great first quarter from a bottom line perspective, increasing its adjusted EBITDA by over 70% from the first quarter of 2023. Now I’d like to touch on the motor and the consistency that Hillman delivers. What differentiates Hillman allows us to produce shelf healthy financial results and makes us an embedded partner for our retail customers is our ability to bring value and solve problems for our customers that others can’t.
Our competitive moat consist of three main pillars. First, we have 1100 sales and service folks that are in the stores of our customers on a regular basis, providing top-notch customer service at the shelf. We’ve been taking care of our customers for 60 years and the Hillman’s service team has been winning at the shelf and adding value to our customers for the past 28 years. Second, we ship direct to store of our retail customers. Said differently, our products typically do not flow through our customers’ distribution centers. Our customers love that because they do not have to clutter their DCs with thousands of SKUs and they know Hillman can ship it direct to the store and service the Shell. We shipped over 46000 locations across North America in 2023.
And lastly, approximately 90% of our revenue comes from brands that we own and control, which allow us to anticipate and meet the evolving needs of our retail customers and our end users. Another key component of Hillman brings to the table is our long-term standing relationship with our customers, from store managers to merchants, to VPs and up. We have been forging strategic partnerships with our customers that further strengthen our moat and have been working with our top five customers for over 25 years on average. As one of the largest providers of hardware products and solutions in North America, we offer 114,000 SKUs that serve the pickup truck pro and the DIYer. We provide a wide variety of hardware and related products across multiple product categories.
Our products are used for repair, maintenance, remodel and these projects cannot be completed without Hillman type products. It’s great to have the critical products that make up just a fraction of the overall project cost. The predictable nature of our end markets repair and maintenance projects in particular, drive consistent demand for our products and both up and down economic cycles. The perfect example of this is demonstrated by hardware solutions, which makes up 60% of our business. Over the past 20 years, 10 years and five years, HS has grown at a compounded annual growth rate of 7%, 7.3% and 8.2%, respectively. Historically, we do not see the highs nor the lows of the market like many companies. During 2022 and 2023 the home improvement industry has been under pressure yet Hillman continued to perform well, like it has for the last 60 years.
Despite a tough macro environment, we continue to win new business, deepen our partnerships with our customers and strengthen our competitive moat. We feel very good about where we are with our customers right now and how team Hillman is performing. We will continue to execute well during this cycle to control the controllables. That said, I know this team and our customers will be ready to ramp quickly when the market improves. With that, I’ll turn it over to JMA to talk about freight costs, the integration of Koch acquisition and the M&A landscape. JMA?
Jon Adinolfi: Thanks Doug. Before I get into our operational highlights for the quarter, I first want to give a shout out to our global operations team for giving a fantastic job in 2023, which is carried into 2024, from transferring our hubs to Kansas City, working to get our product shipped to our customers, maintaining healthy fill rates and reducing inventory. We have a very experienced team that knows how to take great care of our customers. They are the best in the business. Coming off a successful 2023 to continue that momentum into the first quarter of this year, we maintained our focus on executing our plan while controlling the controllables. Let me start by quickly hitting on inbound freight costs, which we locked in on May 1.
Given volatility in the spot market, filing turmoil in the Red Sea and delays at the Panama Canal, we are pleased that we have locked in our base contracted container rates that are about 10% higher than what we contracted last year. This is about one-half of the increase we are planning for. Many of our input costs like steel from China, India and Taiwan increased slightly during the first quarter of 2024 versus the 2023 average, but remain below the 2022 averages. During January of this year, we closed on the acquisition of Koch industries, a Midwestern based supplier of rope and chain and related hardware products with over 2,000 SKUs in a modest customer overlap. We’ve been courting Koch for several years now that our leverage has improved and should continue to come down the timing was right to acquire Koch.
Koch was a great family-owned business and has a rich history. We are excited to welcome Koch to the Hillman family. From an integration standpoint, things have gone smoothly and my hats off to the Hillman and Koch team for doing a great job in doing so ahead of schedule. Importantly, their customers as well as ours are onboard and very excited to see Hillman enter this space. What we love about this acquisition is our ability to leverage Hillman’s moat and resources with Koch’s products. Let me walk you through several examples. First, Koch’s sources most of their products from Asia and we will leverage our sourcing network to be more efficient on this front. Second, Koch shifted its products to distribution centers of its customers.
It does not ship store direct by Hillman. We see this as a great opportunity to expand among the traditional hardware customer. Third, Koch previously used a third party to services product at the shelf, which will now be serviced by the Hillman team. This has allowed us to save on costs and improve the quality of service at the shelf for a very tricky category to keep in stock and looking clean and organized each and every day. Fourth, Koch did not do any business with Home Depot or Lowe’s, and only has a growth business at Ace. Altogether, approximately 90% of the growth in key market with these customers is white space, which we believe we can grow into. And fifth, Koch does not sell any of its products into Canada. With our market share and relationships north of the border, we believe we will grow in Canada as well.
All in, we are excited about the organic growth opportunities with Koch. Once we apply the Hillman moat, our sales team is thrilled to have this product category to sell and service the shelf. As we think about the M&A landscape, we think there are many companies like Koch out there that would perform exceptionally well with our moat and our relationships. We have a dedicated M&A team. We understand the project management and integration and believe that we can execute multiple successful acquisitions per year that are a similar size to Koch. Once the M&A flywheel gets turning, it will drive our long-term growth including organic growth. We will leverage the Hillman moat as we seek more products to put on the truck to deliver directly to and service for our customers.
For example, I would be disappointed if we don’t grow Koch’s net sales by at least 20% next year. With that, let me turn it over to Rocky to talk financials. Rocky?
Rocky Kraft: Thanks Jon. Let me jump right in, net sales in the first quarter of 2024 grew $350.3 million, an increase of 0.2% versus the prior year quarter of $349.7 million. First quarter adjusted gross margin increased by 610 basis points to 47.6% versus the prior year quarter of 41.5%. We have worked really hard to get here and I am proud of our team and how we are performing in a challenging environment. Adjusted SG&A as a percentage of sales increased to 32.7% during the quarter from 30.3% from the year-ago quarter. Excluding the increase in our standard employee bonus expense, which was the result of a very strong bottom line during the first quarter, adjusted SG&A as a percentage of sales would have been up just 50 basis points and should be around 30% for the remainder of the year.
Adjusted EBITDA in the first quarter was $52.3 million, which grew 30.2% versus the year ago quarter. Adjusted EBITDA to net sales during the quarter was 14.9%, which compares favorably to 11.5% in the year ago quarter. Adjusted EBITDA was driven by a positive mix of price cost, which drove healthy margins, partially offset by a soft macro environment. Now let me turn to our cash flows. For the 13 weeks ended March 30, 2024, operating activities generated $12 million of cash as compared to $32 million in the year ago period. Capital expenditures were in line with our expectations, totaling $17.8 million for the quarter. This compared to $18.1 million in the prior year period. Free cash flow for the 13 weeks ended March 30, 2024, total use of $6.1 million, compared to generating $13.4 million in the year ago period.
After taking into consideration the Koch acquisition and our typical seasonal inventory build this was in line with our expectations. Now, let me turn to the balance sheet. We ended the first quarter of 2024 with $747.5 million of total net debt outstanding, an increase of $25.1 million from the end of 2023. We ended the first quarter of 2024 with approximately $242 million of liquidity, which consists of $212 million of available borrowings under our revolving credit facility and $31 million of cash and equivalents. Our net debt to trailing 12 months adjusted EBITDA ratio at the end of the quarter was 3.2 times compared to 3.3 times at the end of 2023 and a full turn better than 4.2 times a year ago. Looking forward, we maintain our expectation that we will end 2024 around 2.7 times net leverage, assuming we fall near the midpoint of our guidance.
During the quarter, we also repriced our term note. In so doing, we lowered the interest rate spread by 36 basis points on our borrowing costs. Additionally our first lien leverage ratio as defined by the term loan credit agreement has somewhat dropped below three times following our Q1 results, which should result in another 25 basis point savings on the term note. All in, we expect to save about $2 million during 2024 as a result of these two reductions and are pleased with these savings considering the flattening of the forward curve. As Doug mentioned earlier, we are reiterating our full year 2024 guidance across all three metrics. We reiterate our full year net sales to be between $1.475 million to $1.555 billion with a midpoint of $1.515 billion.
This midpoint assumes a 1% headwind from price and 1% decrease from market volumes, a 2% lift from new business wins and a 3% lift from the Koch acquisition. All together the net sales midpoint implies a 2.8% increase over 2023. We are reiterating our full year 2024 adjusted EBITDA guidance to be between $230 million and $240 million with a midpoint of $235 million. This midpoint represents an increase of about 7% versus 2023. We continue to expect our full year adjusted gross margins to come in above 45%, which is where we expect the business to perform over the longer term. Lastly, we are reiterating our full year 2024 for free cash flow to be between $100 million to $120 million with a midpoint of $110 million. This is slightly below our longer-term target, as we over-index on free cash flow during 2023, due to our working capital benefit.
Longer term, we expect normalized free cash flow to be around $130 million to $140 million for the next several years starting in 2025, which is mainly driven by increased earnings with a minimal impact from working capital. The assumptions that have driven our guidance remain unchanged at this point, and are available in our earnings call presentation. As we talked about in our last earnings call, if the market remains soft in 2024, our top line could look similar to 2023. If that is the case, we still feel very confident we will grow our EBITDA as we benefit from lower COGS and efficiencies as we continue to run our business well and control the controllables. Looking further out to a more healthy macro environment, we believe our longer-term growth algorithm remains intact.
Historically, our business has seen organic growth of 6% per year and high single to low digit double digit organic adjusted EBITDA growth before M&A. And now that the M&A switch has turned on, we think long term top line growth of high single to low teens is realistic and adjusted EBITDA growth in the low to mid teens is achievable. With that, let me turn it back to Doug.
Doug Cahill: Thanks, Rocky. As we navigate through this dynamic market landscape, I want to thank the Hillman team for their dedication and most importantly, for taking great care of our customers whether it’s the seamless operation of our distribution centers, the tireless effort of our sales and service teams or exceptional service provided by our customer support team, your commitment to our customer is commendable. Thank you. Our foremost focus and commitment moving forward is to strengthen our competitive moat, execute our growth strategy profitably and maintain discipline across the business. We firmly believe that this approach will ensure Hillman’s success in the years to come. With that, we extend our appreciation to our valued customers, dedicated associates and supportive shareholders. This concludes our prepared remarks and we’ll begin the Q&A portion of the call. Towanda [ph], open the call for questions, if you would.
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