Q3 2023 Hamilton Beach Brands Holding Co Earnings Call

Participants

Lou Anne Nabhan; IR; Hamilton Beach Brands Holding Company

Greg Trepp; President and CEO; Hamilton Beach Brands Holding Company

Sally Cunningham; SVP, CFO, and Treasurer; Hamilton Beach Brands Holding Company

Adam Bradley; Analyst; AJB Capital

Presentation

Operator

Good day, everyone, and welcome to the Hamilton Beach Brands Holding Company third-quarter 2023 earnings conference call and webcast. Today's call is being recorded, and I would now like to turn the conference over to Lou Anne Nabhan, Head of Investor Relations. Please go ahead.

Lou Anne Nabhan

Thank you, Lisa, and good morning, everyone. Welcome to our third-quarter 2023 earnings conference call and webcast. Yesterday after the market closed, we issued our third-quarter 2023 earnings release and filed our 10-Q with the SEC. Copies are available on our website. Our speakers today are Greg Trepp, President and Chief Executive Officer; and Sally Cunningham, Senior Vice President and Chief Financial Officer. Joining us for Q&A will be Scott Tidey, Senior Vice President, Global Sales.
Our presentation today does include forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in either the prepared remarks or during the Q&A. Additional information regarding these risks and uncertainties is available in our earnings release and 10-Q and our annual report on Form 10-K for the year ended December 31, 2022. The company disclaims any obligation to update these forward-looking statements which may not be updated until our next quarterly conference call if at all.
And now, I'll turn the call over to Greg.

Greg Trepp

Thank you, Lou Anne. Good morning, everyone. Thank you for joining us. I will take the next few minutes to provide an overview of our performance for the third quarter of 2023 and discuss our expectations for the remainder of the year. Then Sally will discuss our financials in more detail. After that, we will take your questions.
We were pleased with our third-quarter results. As expected, revenue returned to growth and increased nearly 2% compared to last year's third quarter. Our gross profit margin expanded by 300 basis points to 26.1%. Average sales price was offset by lower product costs and lower distribution and warehousing costs.
Operating profit increased 54% to $14.4 million compared to $9.4 million in the third quarter of 2022, reflecting the gross margin expansion and flat SG&A. We also continued to deliver significant improvement in net working capital and free cash flow. Sally will discuss the actual results.
Regarding our revenue results in our consumer markets, overall revenue increased approximately 3%. By market, revenue increased in our Latin America and Mexican markets as a result of increased distribution across key retailers. Revenue decreased in our US and Canadian markets as a result of softer demand in the small kitchen appliance category compared to last year.
In our global commercial market, revenue decreased 11%. This decline is attributable to demand normalizing compared to the third quarter of 2022 when revenue grew nearly 36% due to strong post-pandemic demand in the food service and hospitality industries. Additionally, the current year sales decline occurred in international markets, while sales in the US food service and hospitality industries performed well.
As we have discussed in our previous calls this year, for the full year 2023, we expect a solid performance with a soft first half and a stronger second half, which is how the year has unfolded. Our expectations for the stronger second half were based on increase in placements and promotions across many of our North American customers. This year, we're introducing more than 40 new product platforms across a wide variety of categories. These include products in high demand categories like single-serve coffee, personal blenders, ovens, grills, slow cookers, garment steamers, and many others. Our team has done an outstanding job securing placements and promotions for our new products across a broad range of customers and channels. Our new products that are in the marketplace now are selling well overall.
We have also gained market share this year that we expect will benefit us in the fourth quarter and in 2024. We believe our incremental placements, planned holiday promotions, new products, and increased market share position us well for a solid holiday selling season. I will comment on the small kitchen appliance industry in a moment, but first I will note, we are further encouraged that retail sales overall in the US have continued to grow year over year, and consumer spending has been resilient.
At the same time, economists and retailers have expressed uncertainty regarding continued momentum due to inflation and high interest rates. Consequently, consumer spending for the small kitchen appliance industry and the overall marketplace remains challenging to predict. There are mixed signals with some data pointing towards solid trends while others are indicating a potential softening is underway.
Small appliance industry sales decreased modestly through September compared to the same period last year but remained above pre-pandemic levels. While we have seen no indication of a significant drop in spending on the small kitchen appliance category in the near future, we do expect it to end the year down slightly. As always, our final results will depend on the sell-through at retail and retail replenishment orders.
Given the uncertainty in the macroeconomic environment, we've adopted a slightly more conservative view regarding full year 2023 revenue and have slightly lowered our expectation from flat with 2022 to modestly below 2022. We could end up chasing demand depending on consumer spending, but we want to avoid generating increased levels of excess inventory by being too optimistic. Despite the slightly lower revenue outlook, we continue to expect operating profit to be above last year, excluding the nonrecurring $10 million insurance recovery in 2022.
I also want to take a few minutes to discuss our longer-term view. Since our spin off into an independent public company in 2017, we have said that we operate our business for the long term. As a reminder, we have six strategic initiatives to drive long-term growth. We continue to make progress with these initiatives that are designed to drive revenue growth, expand margin, and generate strong cash flow over time.
The initiatives are focused on increasing sales of innovative, higher-priced, higher-margin products in our core North American market. Across our initiatives, we have continued to expand our portfolio of leading trusted brands. We also continue our commitment to consumer-driven innovation and launched 250 new product platforms in the last five years. We expect the momentum to continue in 2024. Let me briefly summarize each initiative.
First, we want to gain share in the premium market. We have a growing number of licensed brands in the premium market including Wolf Gourmet and CHI. Originally, we have established new partnerships with Bartesian and Numilk. We acquired Weston Brands and created the Hamilton Beach Professional brand. In 2022, sales of our premium brands accounted for 15% of total revenue. We expect premium brand sales to be on track with or ahead of that amount in 2023.
Next, we plan to expand in home health and wellness. We launched an initiative to expand our participation in a large and fast-growing home health and wellness market in 2021. We entered into a trademark licensing agreement with Clorox and launched a new line of premium air purifiers under the Clorox brand in 2022. We entered into a licensing agreement with Brita in 2022. In early 2023, we launched a new category for electric countertop water filtration under the name Brita Hub. This electric countertop appliance creates fresh, great tasting water much faster than traditional pitchers.
We've also begun to participate in the home medical market, where several trends are converging that we believe we can drive strategic opportunities for us. The aging population in our country is creating a large pool of individuals who are living with and managing chronic health conditions. Many younger people are doing so as well. There is also a growing shortage of primary care physicians, nurses, and other medical clinicians.
For these and other reasons including advances in technology, the healthcare industry is implementing new solutions that enable patients to manage many of their healthcare needs at home. Often, these solutions combine a connected medical device and digital communications which can provide key information to patients or report information back to medical providers. We believe our company can help both the patients and the medical providers through solutions created under the Hamilton Beach Health banner. For the past few years, we've had discussions with many companies in the home medical market, about prospective collaborations.
A few years ago, we met with a company called Health Beacon which is based in Dublin. Health Beacon is a digital therapeutics company that has created a patent-protected, FDA-cleared system for managing injectable medications which are used to treat a broad range of chronic conditions in home. Their system is a connected countertop medical device that combines with a digital support system to help patients manage their adherence to their prescribed treatment. The device also provides for the safe disposal of sharps. Health Beacon was seeking a relationship with a company that could help them market and distribute their system in the large US and Canadian markets. In June of 2021, we entered into an exclusive multi-year commercial relationship to do that.
In March 2022, we introduced the Smart Sharps Bin from Hamilton Beach Health powered by Health Beacon in the US. Health Beacon has an agreement with a major specialty pharmacy company, and there is a strong pipeline of prospects. As Health Beacon prepare to deploy the system to market, they experienced delays. Unfortunately, this has caused Health Beacon to experience financial pressures and ultimately a cash squeeze. Last Friday, Health Beacon entered examinership, an Irish statutory framework for restructuring companies in financial difficulty.
Hamilton Beach Brands has entered into a facility agreement with Health Beacon, under which we will make secured loans to Health Beacon up to a total of EUR1.85 million or approximately $2 million to fund its operations during the examinership which is a period up to 100 days. Due to our existing commercial relationships with Health Beacon and our knowledge of current (technical difficulty) serving the food service and hospitality industries with small kitchen appliances.
We continue to develop products that support our competitive advantage in the core blending and mixing categories, and we have expanded into new categories as well. We continue to increase our relationship with the regional and global chains. In 2022, sales of our commercial products accounted for 10% of our total revenue. Our sales of commercial products increased 50% in 2022 as businesses in the food service and hospitality industries engaged significant post-pandemic restocking. While we do not expect that growth rate to continue, we do expect the commercial products will continue to be 10% or more of total revenue in 2023 and beyond.
As we expand into new markets, we continue to drive the growth of core brands, continue to invest in driving the growth of our flagship brands, Hamilton Beach and Proctor Silex in our core North American markets. Hamilton Beach remains the number one unit brand in the US. Our rebranding of Proctor Silex's as Simply Better has gained traction in the marketplace.
We are accelerating our digital transformation for the benefit of all the markets we serve. We continue to make significant investments in our well-developed e-commerce capability and digital marketing. Through the first nine months of this year, e-commerce sales accounted for 36.5% of our total sales, up from 35% in the same period last year. In addition to organic growth, we plan to also leverage partnerships and acquisitions. We are actively engaged in the pursuit of additional trademark licensing agreements, strategic alliances, and acquisitions to drive growth in all markets. For all these reasons, we believe we are well positioned to deliver strong results and increased shareholder value in the years to come.
Let me conclude by sharing some early thoughts about 2024. Over the past few years, our strong team has managed through an extraordinary operating environment due to a wide variety of factors such as tariffs, pandemic-driven historic surge in demand, disruptions across the supply chain, and spiking then falling product and container costs. Early this year, we were still working through the remnants of that environment. At this time, however, most suppliers have returned to normal lead times, and transit times have returned to normal. Our biggest challenge in the short term is understanding the expected retailer and consumer demand. Retailers reduced their on-hand inventory levels earlier this year. The point-of-sale trends are down slightly but are still above pre-pandemic levels.
While our revenue is now increasing over 2022, we continue to receive orders that are slightly lower than expected. Economists and retailers are focused on whether consumers will be able to remain as resilient as -- Consequently, we expect retailers to remain cautious in the near term. At the same time, we are excited about favorable feedback from retailers regarding our products and brands. Our investments in our brands and innovation, as well as our leading shares in many categories are all benefits. We are in the process of finalizing our 2024 plan. We expect to provide more details regarding our outlook for next year when we announce our fourth-quarter results.
And now I will turn our discussion over to Sally.

Sally Cunningham

Thank you, Greg. Good morning, everybody. I will start with our third-quarter 2023 results compared to the third quarter of 2022. Net sales increased to $153.6 million in the third quarter of 2023 compared to $150.8 million last year due to increased unit volume that was partially offset by lower average sales price.
Gross profit for the quarter was $40.1 million or 26.1% of total revenue compared to $34.8 million or 23.1% in the prior year. The increase was due to lower product costs and lower distribution and warehousing costs offset by lower average sales price. Selling, general, and administrative expenses were relatively flat year over year at $25.6 million compared to $25.4 million last year with increased personnel-related expenses offset by a nonrecurring insurance recovery this year.
Operating profit increased significantly to $4.4 million for the third quarter of 2023 compared to $9.4 million last year, reflecting gross profit expansion and relatively flat SG&A. Net interest expense decreased by $700,000 to $600,000 for the third quarter of 2023 versus $1.3 million last year. This decrease reflects significantly lower average debt outstanding, partially offset by higher interest rates. Other expense net was flat compared to last year and included currency losses of $400,000 this year.
The effective tax rate for the third quarter was 21.6% compared to 22.8% in last year same period. The lower rate in the third quarter of 2023 was due to a discrete benefit on foreign income in the current year. Net income for the quarter was $10.3 million or $0.74 per diluted share compared to net income of $5.9 million or $0.43 per diluted share in last year's third quarter.
Now turning to our balance sheet and cash flow. Year to date, net cash provided by operating activities increased nearly $109 million to $68.7 million compared to an outflow of $40.2 million in the prior-year period. Significant improvement was driven by our focus on net working capital improvement. We continue to reduce inventory which declined more than $84 million versus the prior-year period, reflecting our inventory reduction and control actions.
Accounts payable was $116.1 million compared to $111.5 million last year, primarily due to the timing of purchases, and trade receivables were $102.2 million compared to $97.8 million, reflecting our higher sales. We allocated our strong cash flow primarily to reduce debt as well as return value to shareholders through the quarterly dividend and repurchase of stock. At the end of the third quarter, net debt was $49.7 million compared to $144.5 million in the same period last year.
During the third quarter, we paid $1.5 million in regular cash dividends and repurchased 82,676 shares at prevailing market prices for an aggregate purchase price of $900,000. Capital expenditures were $2.4 million for the nine months ended September 30, 2023 and compared to $1.6 million for the same period last year. This increase primarily related to internal-use software development costs.
Now turning to our outlook for the full year 2023. As Greg reported, we expect total revenue to be modestly below full year 2022. Operating profit is expected to increase compared to 2022, excluding the $10 million insurance recovery in 2022. Cash flow before financing is expected to increase significantly compared to 2022 as a result of our improvements in net working capital. Our outlook could change if consumer demand and retailer replenishment orders are softer than currently expected.
This concludes our prepared remarks. We will now turn the line back to the operator for Q&A.

Question and Answer Session

Operator

(Operator Instructions) Adam Bradley, AJB Capital.

Adam Bradley

So solid quarter, strong profitability through gross margins. So that was great to see and great to see the free cash flow improving with net working capital. Just a couple of questions. I'll start with one or two and then get back into the queue.
Looking longer term, it's helpful for investors when you share your strategic initiatives. As you look out over the next, say, three years or whatever your outlook is, where do you see the greatest opportunities for dollar sales growth from your strategic initiatives just speaking broadly?

Greg Trepp

Sure. I think what I feel good about is we do have a nice mix of initiatives. They all have high potential. We feel really good about all of them. And as we've experienced and as folks know that some of those things will grow at different rates than others, so I think right now that if I think about the core business, Hamilton Beach and Proctor Silex, given the fragmentation of the market, that has significant upside. It's hard to get that growth, but it has upside.
Certainly, the commercial market has global -- it's a global business that we're expanding a number of categories that have strong growth potential. The premium business is a third of the market dollars. And so while this has moved up in our mix as a weight of our mix, we have a long way to go to get a top share in the premium segment. And then home health and wellness area is really all new to us, so it's one of those positions that we're in that we feel really good and every year we're investing in high growth potential.
They all will reach their full potential and some of them will take longer than others. But I do feel like the core probably has the highest growth opportunity and then I think followed very closely by the other -- or the markets I mentioned, the home health, commercial, and premium.

Adam Bradley

So I'll ask one more follow-up, and then I'll get back into the queue. It's a very strong gross margin quarter. In fact, I looked back through historic numbers, I can't find another quarter with 26% gross margin, so great job on that for investors. Can you tell us a little bit more about what's driving this? I think you mentioned in the Q and in your release that it's driven by mix.
If we overlay that to the strategic initiatives, is it premium, is it more of a cost thing? Can you just give us a little more color on gross margin? And to give it more context, gross margin historically for Hamilton Beach has been the single greatest driver of profitability and the one that's most variable, and helping investors understand what really drives that would give us a better line of sight into the company's performance.

Greg Trepp

Sure, great. Good question. Certainly, expanding our gross margin percentage is a big focus of us, of the management here, and the initiatives that we're focused on have the potential to do that and help us with that goal. I will say that as costs skyrocketed higher over the past two years, particularly last year, we worked very, very hard to pass along those costs. We were not trying to do anything other than to offset our costs to retailers and consumers, but it is very hard to keep up with a skyrocketing cost position.
As they have dropped pretty quickly, we have adjusted our prices to be competitive, but also we have not had to pass them all along yet. We also have nice movement in some of our initiatives. Some of our premium products and commercial and other areas too play an important role in our gross margin percentage. So I think right now, there has been enough movement up and down that it is difficult to know over the long term how much of that will be able to be consistent about. These are very, very strong numbers.
In the past, what we've said is we believe we are confident we can stay in our historical range of gross margin percent, and our goal is to move higher than that historical range. So really, our biggest focus is let's run our business where we drive top line, we deliver gross margin in or slightly above our historical range, and we control our costs. And that should drive profit percentage and dollar expansion pretty nicely.
So what I would say is, we'll see how the volatility in the cost structure sells out over the coming quarters. We're going to stay competitive and hold on as much margin as we can. So we'll see how that plays out in the coming year.

Adam Bradley

Now I'll jump back in the queue and wait my turn for the next question.

Operator

(Operator Instructions) And we do have follow-up questions from Adam Bradley with AJB Capital.

Adam Bradley

All right. So following on that, I think your press release or the Q talked about your gross margin being driven in part by savings from warehouse and distribution, and I know you guys took on a big project to relocate, and now you have a newer and better distribution warehouse system. Can you tell us a little bit about -- can you quantify the savings from it at least to start like how should investors look at that on a go-forward basis, and how much of the gross margin capture here was due to warehousing and distribution?

Greg Trepp

We're not going to break that out specifically, Adam, but just directionally, I will say that, again, with the pandemic surge in labor, surge in gas prices, the whole the whole supply chain went crazy last year, as you all know. And so we also do have moved to a facility that we are very excited about, and we continue to work on ways to be more efficient in all aspects of our distribution system. So I think we are improving the efficiencies of our system compared to the year before and the year before that.
The market costs become more normalized. There's still some pressures in certain areas. But overall, I think it's -- I think it is a combination of our new facility, our team getting settled in there, and then the market conditions being more favorable as we go forward. So I'd say, to me, the key driver was the change in product cost and inbound freight cost, and a important but lesser influence was the distribution of outbound cost in terms of the margin change.

Adam Bradley

Okay. So --

Sally Cunningham

This is Sally. Maybe I will add to that, right, as you've obviously seen through our networking capital, there is significant reduction in inventory, right, and so if I think about distribution and warehousing, there is a direct correlation. If you have less inventory on hand, you have lower warehousing costs, right?
And to the point where this time last year or this year, I guess I would say, we've consolidated warehouses, right? So we're actively working to keep our inventory levels lower, so we can keep our warehousing costs lower. So you'll see that as a continued theme going forward, too.

Adam Bradley

Right. So thanks for that color. That gives investors like me a little bit of a better window into performance. So along the lines of net working capital is a follow-on to that. So first of all, just tremendous performance in unwinding the net working capital position that had been built up over time. Historically, your business has been one that assuming normality in supply chain or at least stability, let's call it, element of stability, you're a cash-generating business due to your asset-light nature.
So as we look at your strategic initiatives and your opportunities and now cash production rather than consumption through net working capital, can you tell us a little bit more about the capital allocation plan for Hamilton Beach? I know you've laid out dividends and acquisitions, but just your view over the next three years of where the best places to build value are in terms of capital allocation.

Sally Cunningham

Yeah. This is Sally again. That's a great question. I think that's something that we're working through right now to take into our 2024 plan and our three- to five-year strategic plan. I mean, obviously we've allocated the cash flow to reduce debt, right? And we're getting it down to a comfortable level. I think we've talked about 1.5 to 2 times EBITDA, right, as our comfortable debt level.
And so as we look out, I think we'll continue to have the viewpoint that we want to allocate free cash flow to our strategic initiatives and opportunistically to M&A where it makes sense. Specifically which initiatives, I think we're still working through right now. But certainly, we want them to be growth drivers.

Adam Bradley

Yeah. And I guess it seems like some of the strategic initiatives are maybe more capital intensive than others. But overall, the M&A space, it's a tough time to sell business and a better time to buy one right now. Can you tell us a little bit more about what you're seeing in the market and your overall view of acquisitions? Do you look for more bolt-on that you can easily integrate or are you looking -- if you found something that was big, would you go after it? I know it's tough to be hypothetical, but I think investors want to understand what the thinking is at least and if opportunity is available, how you might respond.

Greg Trepp

So Adam on the how opportunities are presenting themselves or bubbling up, I do think that this environment is putting pressure on those folks that were not well positioned or overextended or whatever might cause a company to go into a pressure situation. So this is definitely a time when having done the blocking and tackling, the important work during the pandemic, it puts the company in a better position post pandemic. And I feel really good the team here did that. So I do think there will be an increase in opportunities for us to look at.
It has been still relatively quiet, but there has been a little bit of activity on the front of opportunities presenting themselves. But we're going to look at anything and everything that makes sense for us and evaluate it. I'll say more likely it's going to be a bolt-on opportunity, but we have a very sophisticated Board who views -- they're really focused on driving long-term shareholder value. So if there were something that was more larger opportunity to combine or buy or do something in the long term, they would definitely look at whatever opportunity presented itself.
So in the end, I think I'm assuming we're going to see something here in the coming year to at least evaluate whether it makes sense for us, and that will be really focused on if it was at the right price for the opportunity in front of us.

Adam Bradley

Okay. Thank you for that. I think we got it. I think that answers my question in general terms, so I appreciate it.

Operator

There are no further questions at this time. I'd like to turn the call back over to our CEO, Greg Trepp, for any additional or closing remarks.

Greg Trepp

Thank you. Today we've discussed our commitment to building long-term shareholder value supported by our many competitive advantages and our strategic initiatives. We benefit from our leadership in the small kitchen appliance industry which has a long history of strong durable demand. Our team is experienced with strong industry, customer, and consumer knowledge. We have a strong portfolio of well-known trusted brands anchored by our flagship brands, Hamilton Beach and Proctor Silex. We are a proven innovator.
Our retail relationships span a broad group of customers in brick and mortar, omnichannel, and e-commerce channels. We have an asset-light global infrastructure. We plan to leverage all of these strengths in 2024 and beyond.
That concludes our report for today. Thank you again for joining our call.

Operator

Thank you and that does conclude today's presentation. Thank you for your participation, and you may now disconnect.