Huttig Building Products, Inc.

Thank you, operator. Thank you, and welcome to Huttig's Third Quarter 2021 Earnings Call.

With me this morning is Jon Vrabely, President and Chief Executive Officer; and Bob Furio, Executive Vice President and Chief Operating Officer. During the call today, we will discuss our third quarter 2021 operating highlights and financial results.

We will also provide commentary on the current business environment, including continued progress we have made across various facets of our operations. Following our prepared remarks, the operator will open up the line for questions.

Let me take a moment to remind you that today's discussion reflects management's views as of today and may include forward-looking statements. Actual results could differ materially from those anticipated, and Huttig disclaims any obligation to update information discussed on this call because of developments that occur afterward.

In addition, to the extent you are listening to this call on replay, information could have already changed. Additional information about factors that could potentially affect the financial results is included in the earnings release issued yesterday and in our filings with the SEC.

During this call, certain non-GAAP financial measures will also be discussed. A description of any non-GAAP adjustments and reconciliation to the most comparable GAAP measures can be found in the earnings release issued yesterday and on the company's website at www.huttig.com.

Today's call is being webcast live and is being recorded. If you ask a question, it will be included in our live transmission and in any future use of the recording.

You can replay the call on the Investor Relations page of the website. Now it is my pleasure to turn the call over to Jon for opening remarks.

Thank you, Phil. Good morning, and thank you for joining our third quarter 2021 earnings call.

I am extremely pleased with our continued strong momentum as we report another solid quarter of operating results while continuing to transform our business and financial models. The actions we have taken over the past several years are having a meaningful impact across virtually every key facet of our financial performance, including sales, gross margins, operating leverage, profitability and liquidity.

Despite the challenging business environment due to continued supply chain disruption and lack of available labor, total new residential housing starts are up approximately 8.5% from the third quarter of 2020. While the new residential construction market has been somewhat choppy, after a brief interruption in the second quarter of 2020, new home starts have generally continued their pre-pandemic moderate growth trajectory.

To provide some perspective, if total new starts in the fourth quarter of this year are flat with the fourth quarter of last year, total new starts this year will approach 1.6 million the highest level of annual starts since 2006. The pandemic continues to create economic uncertainty, but barring any unanticipated macroeconomic disruption, we believe the underlying fundamentals of the housing market remain very strong, which supports our positive future outlook.

Moderate growth in demand for residential building products and our focus on disproportionately growing our strategic product categories contributed to our sales increase of 15.3% in the third quarter. Like many companies, certain market conditions created by the pandemic have both challenged and simultaneously benefited our performance.

Based on the respective sales mix of key product categories, these challenges and benefits have had a uniquely different impact across many companies in the industry and, in large part, due to the respective organization's reliance on commodity product sales. Generally speaking, the greater the percentage of commodity product sales a company has relative to their total sales, the greater level of volatility they will experience as demand and supply eventually rebalance.

The pandemic-related market conditions have also added a level of analytical complexity that makes it more difficult than usual to estimate future sustainable performance as compared to reported results. Throughout the year, we consistently and comprehensively analyzed the business in an attempt to identify and quantify the net effect that the pandemic has had on our 2021 performance.

Illustratively, while product availability challenges have significantly hampered sales of exterior doors, opportunistic sales increases in other strategic categories substantially offset lost sales in the exterior door category. Based on our internal analysis, on a net basis, we do not believe the current market conditions have meaningfully affected our total net sales.

Based on our strategic products -- based on strategic product categories generating significantly higher gross margins as compared to our other product categories, growing our strategic categories at a faster rate than our other categories contributed to our gross margin improvement of 310 basis points in the third quarter. We are pleased to see the results of our actions in our financial performance and are excited about the prospect of continued margin growth as we continue to execute our margin expansion initiatives.

Current levels of constrained supply, combined with the current inflationary pricing environment across most product categories makes it difficult to estimate future sustainable gross margins. Illustratively, exterior doors, and particularly value-add fabricated exterior doors, generate the highest gross margins in the company.

Throughout 2020 and 2021, significant supply constraints resulted in missed sales opportunities in exterior doors, which negatively affected our gross margins. However, we believe margin gains in other categories substantially offset the lost opportunity in exterior doors.

Based on our analysis, on a net basis, we believe our year-to-date gross margins of 22.3% is within a reasonable future sustainable range of performance and possesses upside with continued sales growth of our higher-margin categories. While the inflationary environment has led to increases in certain operating costs, we have successfully leveraged our cost structure, which also contributed to our strong financial performance in 2021.

For the third quarter, our operating expense ratio was 16% of sales as compared to 16.8% in the prior year quarter. And on a year-to-date basis, our operating expense ratio is 16.4% as compared to 18% for the same period in 2020.

In light of the pandemic-related market conditions, the combination of relatively strong demand for residential building products and the continued execution of our strategy contributed to our very strong adjusted EBITDA performance in 2021. In the third quarter, we generated adjusted EBITDA of $17.5 million or 7.1% of sales as compared to $8.5 million or 4% in the prior year quarter.

On a year-to-date basis, we generated adjusted EBITDA of $45.4 million or 6.4% of sales as compared to the first 9 months of 2020 of $17.7 million or 2.9% of sales. In addition, through our strong operating performance and benefits derived from our new credit facility, we increased liquidity by nearly $100 million to $168.5 million.

In closing, I want to speak briefly about Huttig's Board of Directors' recent announcement related to its current strategic review process. Our Board of Directors has always directed the company in a manner that it believes will maximize value for all shareholders.

To that end, as it has always done, the Board consistently reviews all strategic options to determine the course of action it believes is in the best interest of all shareholders. No assurances can be given regarding the outcome or timing of the review process.

Huttig has not set a timetable for completion of the review process and does not intend to disclose developments related to the process unless and until the Board determines that further disclosure is appropriate or required. We will not be able to provide additional information or address questions related to this matter during our call due to the ongoing review process by our Board of Directors.

I will now turn the call over to Bob to discuss our third quarter operating performance.

Thank you, Jon, and good morning, everyone. I will provide an update on our operational and sales initiatives and discuss specific factors that affected our third quarter operating performance.

Phil will then discuss our third quarter financial performance. While we are pleased with our sales performance in the third quarter, our total growth opportunity remains hampered by product availability and continued labor shortages, which is a common theme across many businesses.

However, we are gaining more clarity around the supply chain issues and are beginning to form an outlook as to when they may subside across several key product categories. We've had 4 major strategic categories impacted by supply issues to varying degrees throughout parts of 2020 and continuing through 2021, although product availability has recently improved across some categories.

While the environment is still fluid, based on discussions with our key supply partners, we anticipate that the supply chain could begin to normalize as early as the second quarter next year. This outlook applies to our core strategic categories, though ocean freight remains an issue with respect to our fastener products, and to a lesser degree, raw materials used by many of our supply partners.

Our fastener sales continue to be robust this year despite the ocean freight issues, in part due to the strong inventory position held at the onset of the pandemic, but more significantly, we believe we are expanding share in this important strategic category. While our inventory position has leveled, we continue to aggressively manage the procurement process to help ensure adequate product availability.

I would also like to discuss the current pricing environment. Throughout our industry, like many other industries across the globe, we have seen significant price inflation.

Strong demand, coupled with product constraints have elevated the situation. However, we do not have the same level of exposure to short-term commodity price fluctuations as some other companies in our industry.

For example, our exposure to local products is relatively small, and we believe that the majority of price increases we have realized in our business, based on our product offering, will remain intact. Our business is not highly commoditized, which is something we have discussed as an emphasis point for us, and which is why we continue to review product rationalization opportunities.

This, along with our focus on strategic categories, is just part of the business transformation Jon mentioned. We believe our broad, value-based product offering will help shield us from significant, volatile and impactful commodity swings as we move forward.

Not only do we expect pricing to remain intact for the near future, there is a strong likelihood that we will continue to see some level of price deflation as we move into 2022. Our areas of focus continue to center around growing our strategic product categories, pricing management, which is critical in this environment, and improving our operations to drive operational efficiency, allowing us to continue to leverage our cost structure and provide a high level of service to our customers.

Sales of our national strategic categories grew 13.4% and accounted for 44.4% of our total growth for the quarter. Combined with sales of our local strategic categories, those identified on a local market basis, total strategic category sales grew 18.4% and accounted for 99% of our total sales growth for the quarter.

Growth in these categories was in part due to strong demand, coupled with price inflation, but more notably, gains from our continued focus on these important product categories. As a percent of total sales, national and local strategic categories grew from approximately 80% to 83% for the quarter and from 79% to 82% on a year-to-date basis.

This planned intentional mix shift has resulted in our ability to successfully replace sales of lower-margin, nonstrategic products, with increased sales of strategic categories, whose average shipping margin in the quarter is 480 basis points higher than prior year without incurring meaningful, incremental operating costs. To illustrate, while national strategic categories represented 49% of our sales in the quarter, they represented 56% of our shipping profit.

For the quarter, composite deck rail and trim sales increased over 9%. Huttig-Grip fastener sales increased nearly 26% and prefinished exterior doors increased 21% despite challenges from the supply chain and despite the labor shortages, which have created a higher backlog in our production business.

While we are pleased with our growth in the strategic building products categories, fabricated door sales were more severely impacted by supply chain disruption and grew by 8% for the quarter. In addition to achieving national strategic category sales growth and meaningful category mix shift, we also grew our shipping margins on these products by 520 basis points in the quarter and by 350 basis points on a year-to-date basis.

The changes we have made to our business model over the last several years are driving our strong results, and we have more runway ahead. There continues to be a significant opportunity across our initiatives, and we intend to harvest that opportunity to drive continued meaningful improvement across our business.

Now I will turn the call over to Phil to discuss our financial performance.

Thank you, Bob. Third quarter 2021 net sales were $245.3 million, which was $32.6 million or 15.3% higher than the third quarter of 2020.

For the first 9 months of 2021, our net sales were $707.4 million, which was $99.7 million or 16.4% higher than 2020. We estimate that restructuring activities announced in the second quarter of 2020, along with our 2020 product rationalization program, has the effect of moderating our year-to-date sales growth by approximately 3 points.

Our sales growth was driven by an improved residential construction market, a favorable pricing market, included elevated levels of inflation and by growth in certain strategic product categories. The inflationary environment has been elevated by demand-driven pricing with higher input costs throughout the channel, including labor and materials and is reflective of the challenges within the supply chain and labor markets.

Gross margin was $56.8 million in the third quarter of 2021 compared to $42.7 million in the third quarter of 2020. As a percentage of sales, gross margin was 23.2% in the third quarter of 2021 compared to 20.1% a year ago.

For the first 9 months, gross margins were $157.8 million compared to $122.3 million in 2020. As a percentage of sales, year-to-date gross margins were 22.3% compared to 20.1% a year ago.

Gross margins were favorably impacted by our continued focus on noncommoditized strategic product lines which carry higher margins, as well as effective pricing management in an inflationary environment. We also benefited from increased purchasing incentives in 2021.

The increase in our gross margin percentage from these actions more than offset the impact from a disproportionate increase in our lower margin direct sales in 2021 as compared to 2020. As we value our inventories on a last-in first-out basis, or LIFO, the impact from the current pricing environment had a higher-than-normal moderating effect on our gross margins in 2021.

Operating expenses were $39.3 million in the third quarter of 2021, which were $3.5 million or 9.8% higher than the $35.8 million reported in the third quarter of 2020. Personnel costs increased $2.2 million or 10.4%, reflecting increased variable incentive compensation from improved operating results, wage increases and reinstatement of compensation reductions and other cost reduction actions taken in 2020.

These increases were partially offset by a $1.5 million Cares Act Employee Retention Tax Credit and by lower medical costs. Nonpersonnel costs increased $1.3 million or 8.9%.

The increase was primarily driven by higher fuel, insurance and tax costs. Overall, our cost structure was levered against higher sales volume.

As a percentage of net sales, operating expenses were 16% in the third quarter of 2021 compared to 16.8% in the third quarter of 2020. Operating expenses were $115.7 million for the first 9 months of 2021, which was $6.2 million or 5.7% higher than $109.5 million reported for the same period a year ago.

Personnel costs increased $6 million or 9.6%, again reflecting increased variable incentive compensation from improved operating results, wage increases and reinstatement of compensation and other cost reductions taken in 2020. These increases were partially offset, again, by the lower medical costs and a $1.5 million Cares Act Employee Retention Tax Credit.

Nonpersonnel costs increased $200,000 or 0.4%. Higher fuel, insurance and tax costs were offset by lower contract haul expenses, reduced operating rent costs and an improved bad debt provision.

Overall, our current cost structure was levered against higher shares volume. And as a percentage of net sales, operating expenses were 16.4% in the first 9 months of 2021 compared to 18% in the first 9 months of 2020.

In the third quarter of 2021, we recorded a $1.6 million gain on the sale of our Selkirk, New York, facility which was closed as part of our 2020 restructuring activities. Selkirk's operations were merged with our facility in Millington, Connecticut.

Operating income in the third quarter was $19.1 million compared to $6.9 million a year ago. For the 9 months ended September 30, operating income was $43.7 million compared to $1.8 million a year ago.

And adjusted for the $1.5 million restructuring charge and $9.5 million noncash goodwill impairment charge recognized last year, 2020 year-to-date operating income was $12.8 million. Net interest expense was $700,000 in the third quarter of 2021 compared to $800,000 in the third quarter of 2020.

For the first 9 months of 2021, net interest expense was $2 million compared to $3 million a year ago. Lower interest expense reflects both lower average debt balances and a continued favorable interest rate environment.

As a result of the foregoing, we reported net income of $18.7 million in the third quarter of 2021 compared to $6.1 million a year ago. On a year-to-date basis, net income was $41.7 million in 2021 compared to adjusted net income of $9.8 million a year ago.

Adjusted 2020 net income reflects adjustments for the $9.5 million goodwill impairment charge and the $1.5 million restructuring charge. We generated adjusted EBITDA of $17.5 million during the third quarter of 2021 compared to $8.5 million in the third quarter of 2020.

For the first 9 months ended September 30, adjusted EBITDA was $45.4 million compared to $17.7 million a year ago. Our third quarter operating performance brings our last 12 months adjusted EBITDA to $47.8 million.

Turning to the balance sheet. We had total debt of $78.2 million at September 30, 2021, compared to $101.6 million a year ago, a reduction of $23.4 million.

Our debt reduction is primarily due to cash flows from operations including strict working capital management. Total available liquidity was $168.5 million at September 30, 2021 compared to $69.8 million a year ago, representing an increase of $98.7 million.

As we turn to the fourth quarter, based on October's performance, we continue to see solid business momentum with a favorable market outlook. This concludes our prepared remarks on our third quarter financial performance.

Operator, we will now take questions.

Jon, so can you just talk about the gross margin, I think you talked about the 9-month gross margin you view as kind of maybe the new norm. Is most of that improvement just the product rationalization, because that's quite an increase over the historic percent?

Yes, it's a great question, Alan. And I will tell you that we, as I said in the script, dug in deeply and have all throughout the year trying to really understand what's driving our improvement in gross margin.

And as you said, product rationalizations. There's certainly a component of that.

As we talked in prior calls, particularly throughout 2019 and even into early 2020, we were going through a pretty significant first round of product rationalizations and that is certainly having an impact on our current margins. In addition to that, accounting for what we would view as opportunistic kind of increases in more commoditized items, taking that into consideration and the fact that those margins may actually come down as supply and demand rebalances, as well as price increases in what we would view as branded, noncommoditized products, we feel that we can sustain our year-to-date margins of 22.3% based on everything we know today and the analysis that we've done.

So I think it's a combination of all of those issues and all of those factors. And I think that we feel pretty good about that 22.3% being within a reasonable, relevant range of sustainability going forward.

Okay. Great.

And my last question was can you just go through again the positives and negatives on the exterior doors, kind of what impact that really had in your 9-month or quarterly results?

Yes, Alan, so this is Bob. If I understand your question correctly, I think, certainly, there's been some price inflation which has helped, on a quarterly growth basis, the increase.

But offsetting to that is certainly the constraints on supply and the fact that we have gotten limited or allocated proportionate share of door slabs compared to prior years. So the fact that we can't get all the raw material that we need in order to produce stores has been offset to a certain rate by some level of price inflation.

Thank you, operator. In March of 2020, as the pandemic raged across the globe, we found ourselves in an environment with the highest level of uncertainty I have ever seen in my career.

The aggressive and proactive measures we took are now well documented and discussed on a number of past earnings calls and in our SEC filings. Over the past 18 months, we have successfully navigated through a multitude of challenges and achieve meaningful, sustainable improvements in the business.

These gains have made -- the gains we have made in the execution of our sales growth, margin expansion and expense management initiatives all contributed to our strong current performance. These sustainable improvements have resulted in our ability to leverage higher sales volumes of our highest margin product categories across an improved expense structure.

Our strategy and successful execution of our business plan is working. And when it works, new levels of performance are achievable.

When it works, and our highest-margin categories also possess the greatest opportunity for future growth, new levels of financial performance are achievable for many years into the future. Today, our financial performance is as strong as it has been since becoming an independent publicly traded company in 1999, and we are well positioned to build on our current performance moving forward.

Our performance would not be possible without the commitment and dedication of our entire team of associates. I am very proud of the entire organization as our collective efforts have created a very bright future for our company and our stakeholders.

I want to thank them again for their hard work, fortitude and dedication to providing exemplary service to our customers. I also want to thank our customers and supply partners for continuing to place their trust in us to care for their business.

Finally, I thank you for your ownership and interest in our company and for your participation in our call today. We look forward to speaking with you again when we report our fourth quarter and full year results.

Operator, this concludes our call.