Welcome to the Griffon Corporation Q2 2020 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and- answer- session will follow the formal presentation. Should anyone require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brian Harris, Chief Financial Officer. Please go ahead.
Thank you. Good afternoon, everyone. With me on the call is Ron Kramer, our Chairman and Chief Executive Officer. Our call is being recorded and will be available for playback, the details of which are in our press release issued earlier today. As in the past, our comments will include forward-looking statements about the company's performance based on our views of Griffon's businesses and the environments in which they operate. Such statements are subject to inherent risks and uncertainties that can change as the world changes. Please see the cautionary statements in today's press release and in our various Securities and Exchange Commission filings. Finally, some of today's remarks will adjust for those items that affect comparability between reporting periods. These items are explained in our non-GAAP reconciliations included in our press release. Now I'll turn the call over to Ron.
Thanks. Good afternoon, everyone. Let me start by saying I hope that all of you and your families are safe and healthy. Griffon entered this unprecedented COVID-19 pandemic from a position of strength on an operational and a competitive basis. Our positive momentum, along with enhanced liquidity and a strengthened balance sheet, enable us to manage the near-term effects of the current environment while continuing to make the necessary investments in our business to execute our strategic growth plan and drive long-term shareholder value. Our top priority has been, and will continue to be, ensuring the health and safety of our employees and our customers. Since early March, we've been proactively implementing health and safety measures across our global workforce. As local and national authorities have circulated additional guidelines for employee health and safety, we've incorporated those as well.
As almost all of our facilities have been open and remain operational, our additional safety measures include increasing the cleaning frequency and enhancing the sanitation of all of our facilities, restricting external visitor access to our facilities, adjusting production schedules and hours of operation to promote distancing between employees in the workplace, implementing work-from-home programs wherever possible, and canceling all travel and unnecessary work travel. These are samplings of the broad actions we've taken across all of our businesses to protect our workers while maintaining critical operations. In mid-March, we also began an appreciation award program to hourly U.S. employees on the front lines working at our manufacturing and distribution sites as recognition of the difficulties they've been facing. This situation has put a tremendous strain on our entire workforce, but they've done an exceptional job keeping our operations running while simultaneously keeping everyone safe.
We owe them our gratitude, not just for doing an outstanding job, but also for supporting operations that are critical to our country. Let's go through some of the specific businesses. In Consumer and Professional Products and Home and Building Products, all of our U.S., Canadian, and Australian facilities are operational. This includes all Ames, ClosetMaid, Clopay, and CornellCookson facilities. Each of these businesses provide critical products supporting national infrastructure. To the extent practical, we are permitting our employees in these segments to work remotely. As I mentioned before, all of our manufacturing and distribution facilities have implemented strict protocols to ensure employee health and safety while at the workplace.
In the United Kingdom, in accordance with U.K. government directives in late March, our Ames UK facilities are not operating at this time, and employees have been directed to stay home until what we expect to be a reopening the end of June. In Mexico, our ClosetMaid manufacturing facility closed earlier in April at the direction of Mexican authorities. This facility supports ClosetMaid sales principally in the U.S. and Canada and is expected to resume operations imminently. Telephonics, our defense electronics business, continues to operate at all of its sites as it provides critical manufacturing and services supporting the U.S. military, and its operations are essential for maintaining our national security. Let me go through an update on the Q2 performance.
Starting with consumer and professional products, we saw a steady demand through the entire quarter for seasonal lawn and garden products, tools, and storage and organizational solutions at major retailers and home centers across North America and in Australia. The U.K. was impacted by the March COVID-19-related shutdown. In home and building products, strong demand for sectional residential and commercial doors continued through the end of the quarter. We also saw increasing demand for rolling steel products in the quarter. At Telephonics, the long-anticipated Lockheed Martin MH-60R FMS program with India was signed. Telephonics received an initial $5 million booking in March, which is the first part of the $50 million in total bookings expected from this production contract. We expect the balance of this contract to be booked in this fiscal year.
Across all of our segments, our suppliers have largely been able to support us, and we've not experienced any meaningful supply chain issues to date. Currently, we have sufficient components and material on hand to sustain our operations without major interruptions. Let's talk about our balance sheet. While the COVID-19 pandemic clearly has eclipsed our typical business update, I want to call out attention to some of the recent developments. In January 2020, we expanded the capacity and extended the term of our revolving credit facility to 2025. We increased the revolver by $50 - $400 million and have an additional $100 million of availability through its accordion feature. On our last call on January 30th, we discussed our intent to refinance a portion of our 2022 bonds.
Shortly thereafter, on February 4th, we completed a private placement, refinancing $850 million of our $1 billion of five and a quarter bonds due in 2022 with 5.75% notes due in 2028. Substantially all of these bonds were exchanged for registered bonds on April 22nd. We're pleased by the success and the timing of the bond offering and revolver expansion, and with how these actions position us for the future. These transactions enhance our liquidity and extend our maturities, reinforcing our balance sheet to weather the unpredictable conditions we're operating in today. Lastly, we expect to continue our dividend program. We understand how important our dividend is to shareholders, and it reflects the resilience of our business, even in difficult times.
To that end, earlier today, our board authorized a $0.075 per share dividend payable on June 18th, 2020 to shareholders of record on May 21st, 2020. This marks the 35th consecutive quarterly dividend to shareholders, which has grown at an annualized compound rate of 17% since we initiated it in 2012. Let me turn it over to Brian for a closer look at the results. Brian?
Thank you, Ron. I'll start by highlighting our Q2 consolidated performance compared to our prior year quarter results. Revenue increased 3% to $566 million, and adjusted EBITDA increased 13% to $48 million. Gross profit for the quarter was $152 million, which included $1.4 million of charges related to the AIM strategic initiative. Excluding this charge, gross profit was $153 million, increasing 12%, with gross margin increasing 210- basis points. Q2 selling, general, and administrative expenses of $126 million included $4.7 million of charges related to the AIM strategic initiative and acquisition costs related to Apta and M&A activity postponed at the end of Q2. Excluding these charges, SG&A expenses were $122 million, increasing 9%. As a percentage of sales, SG&A adjusted for the charges increased 120 basis points to 21.5% due to consulting, COVID-related expenses, and compensation.
Q2 GAAP 2020 net income was $900,000, or $0.02 per share, compared to the prior year period of $6.5 million or $0.15 per share. Excluding items that affect comparability from both periods, Q3 adjusted net income was $10 million or $0.23 per share, compared to the prior year of $6.4 million or $0.15 per share, an increase of 53% on a per share basis. Effective tax rate excluding items that affect comparability for the quarter was 35.9%, and for the year-to-date period was 34.4%. Capital spending was $9 million in the Q2, in line with prior year. Depreciation and amortization for the quarter was $16 million.
Regarding our segments, our consumer and professional products Q2 revenue decreased 4% to $275 million, driven by decreased volume due to prior year new product load-ins and the current quarter impact of COVID-19 on the U.K., as well as an unfavorable foreign exchange impact of 1%. This was partially offset by favorable mix and pricing and the incremental contribution from the Apta acquisition of 2%. Adjusted EBITDA was $25 million, decreasing 13% due to reduced sales and tariffs, partially offset by contribution from Apta. The quarter EBITDA also had a 1% unfavorable foreign exchange impact. Adjusted EBITDA margin was 9.1% compared to 9.9% in the prior year quarter. The AIM strategic initiative continues on plan, and we expect to exit the Belle Vernon, PA and Falls City, Nebraska facilities by the end of fiscal year.
Home and Building Products Q2 revenue increased 12% to $210 million, driven by increased volume and favorable mix and pricing. Adjusted EBITDA increased 52% to $31 million, driven by increased revenue and improved operational efficiencies. Adjusted EBITDA margin was 14.6% in the current quarter, compared to 10.8% in the prior year quarter. Defense Electronics Q1 revenue was $82 million compared to the prior year period of $75 million, primarily due to increased volume. Adjusted EBITDA during the period was $4.2 million compared to the prior year quarter of $4.9 million, impacted by mix and timing of bidding proposal costs. Backlog at March 31st, 2020 was $332 million. Corporate unallocated expenses excluding depreciation were $11.9 million in the Q2.
Regarding our balance sheet and liquidity, as of March 31st, 2020, we had $69 million in cash and total debt outstanding of $1.23 billion, resulting in a net debt position of $1.16 billion and a debt-to-EBITDA leverage of 5.1 times as defined in our debt covenant. Further, we expect benefits from the CARES Act and other legislation to provide $10 million-plus cash inflow to fiscal 2020 and $5 million-plus to fiscal 2021. We have ample liquidity to manage through the COVID-19 pandemic. As previously mentioned, we refinanced our $850 million of our $1 billion five and a quarter bonds through 2022. The maturity of the new bonds is March 28th, with a coupon of 5.75%, having approximately $2.5 million of interest expense for this fiscal year.
Also, during the quarter, Griffon extended its revolving credit facility to 2025 and increased the maximum borrowing amount by $50 - $400 million, with $195 million available on March 31st, 2020. In addition, the facility has $100 million accordion feature. Also note that as Griffon entered the month of April, its seasonal cash generation period started, which typically continues through the end of fiscal year. Griffon's first six months of the year were strong, with our trailing 12-month adjusted EBITDA before unallocated expenses up $17 - $263 million as compared to fiscal 2019 at $246 million. Regarding Q3, we expect the vast majority of our facilities to remain operational as our production and distribution is considered essential. We have ample liquidity and anticipate strong free cash flow in the H2 of our fiscal year.
This, along with the extended maturities of our debt, all serve to support our business as we navigate through near-term challenges. Notwithstanding, there are several factors that are evolving and are unpredictable at this time. These factors include depth and duration of global COVID-19 and related business interruptions, its ultimate impact on economic conditions, and the costs associated with enhanced safety, modified production measures, and appreciation awards. We normally give guidance once a year and do not update that guidance during the year, but these are not normal times. The uncertainty resulting from COVID-19 makes it extremely difficult to provide guidance, and as a result, we have decided to suspend our to 2020 guidance. As you can see from our results, we were making good progress on achieving our guidance of at least $250 million of adjusted EBITDA before unallocated expenses, and we're indeed ahead of that plan.
Our long-term de-leveraging strategy and goal of 3.5x net debt to EBITDA remains unchanged. Let me give you some commentary regarding what we have observed across our businesses over the last six weeks. Beginning with CPP, we continue to see steady demand in North America and Australian markets. However, Ames U.K. currently does not expect to resume operations until July. In Home and Building Products, Clopay residential sectional doors have seen volume declines of approximately 15%-20% during the month of April, but commercial door volumes are steady. We are not expecting a material and have not seen a material impact on Defense Electronics revenue through Q3. Now I'll turn the call back over to Ron.
Thanks, Brian. We had a solid Q2, and our year-to-date performance was well ahead of last year. While we adjust to the current circumstances, our long-term strategy remains intact, and we have the conviction to follow through on the key elements of our long-term strategic growth plans. Our capital investments will continue per our original guidance of $60 million. Recall that roughly half of our capital expenditures are related to maintenance operations, with the other half promoting our growth and competitiveness. We will continue to make all of these investments, including our AIM strategic initiative. As I mentioned earlier, we will continue our dividend program, and while we have $58 million remaining under our board-approved share buyback program, we currently do not intend to repurchase shares. H2 of our fiscal year generates significant free cash flow due to the seasonality of our businesses.
We'll continue to focus on de-leveraging our balance sheet and reaching our goal of 3.5x net debt to EBITDA in the next few years. Our workforce has shown an exceptional dedication throughout this crisis. We all appreciate the importance of their work supporting the critical infrastructure of our global home markets. We'll continue to be proactive with taking measures to maintain their health and safety as we work our way through this pandemic. I'd just like to say that our management team is up to this challenge. We'll persevere through it, and I'm confident that we will build to a bigger and better tomorrow. Operator let's take whatever questions.
Thank you. We will now be conducting a question- and- answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we pull for questions. The first question is from Robert Labick of CJS Securities. Please go ahead.
Hi, it's actually Lee Jagoda for Bob. Good afternoon, Ron.
Good afternoon. How you doing?
Hello. Just starting with the Ames business. As you look into April, are you seeing anything that, dare I even say it, could be a benefit relating to stay-at-home and people gardening? What are you seeing at retail there in terms of sell-through?
We clearly are seeing as people who are at home and as the economy goes through this adjustment to this incredible set of circumstances, people that are home are spending money in and around their house. We are a beneficiary of that. We expect that to manifest itself in our ability to support our retail partners in their e-commerce business. The mega trends of home investment and while it's obviously terribly unfortunate, the level of unemployment that's washing through, there's still a tremendous number of homeowners, and there's still a tremendous amount of liquidity that's provided that people that are home, that are not going to restaurants, that are not going out to shop at retail, and are adjusting their patterns.
We believe that trend, which is clearly within the range of products and the brands that we represent within Ames, is going to be in a sweet spot of what is going to be the new normal of how people spend money in the U.S. The one other point that I'll make is the impact of both monetary and fiscal policy, the $7 trillion that's going to get pumped into our system, is one of the things that gives us some significant hope that the recovery, and particularly that 26 million people that have become unemployed are going to get back into the workforce. The trends around urbanization are likely to end up with more single home ownership. The broader speaking of what this means for Ames is an underlying positive.
Going towards increased investment in the home, can you give us a sense for what has typically happened on the residential garage door side in periods of economic slowdowns? Just as a follow-up to that, are the commodity prices you're seeing related to steel in particular, giving you any tailwind to offset some of the potential volume headwinds?
Yeah, there's a couple of questions in there, but let me start by saying that, in the last housing crisis, the homeownership was a cause of the financial calamity. In this case, the home is a victim of it. The distinction is that whatever economic decline we're currently going through is a result of a natural disaster. Trying to compare this to any prior cycle is informational only. We're too early in this to know with any certainty what the ultimate impact is going to be. Certainly through the end of March, we were seeing not just good volumes, but way ahead of last year in the residential side of the business. Remember, the biggest part of our business is repair and remodel.
New home construction, which there's a clear supply-demand imbalance that we believe this is only going to accelerate when we ultimately get into the recovery phase. It's way too early to talk about what the impact is. The repair and remodel cycle continues. Dealer business, while down, and I think Brian used the number of 15%, 20%, in the month of April. From where we're sitting, we see that means 80%-85% of expected orders. There is very much a heartbeat of an economy that's still going in spite of the lockdowns and all the necessary safety precautions that states have put in place with shelter in place, with lockdowns. How that's going to ultimately go the other way as we start to open up again this week and then prospectively into May and June remains to be seen. We believe we have the leading brand.
We have the best dealer network. We're sold through the best retailers in the garage door business, and we bought the best commercial door business in CornellCookson. We have seen no drop-off in volumes on the commercial side of our business. We remain relatively positive about the trends as we're sitting here in April. The impact of how long this is going to last isn't about economic forecasting or views about politics. It's about science. Ultimately, testing and vaccination will lead to how much people reengage and how quickly the economy recovers.
The one thing that we're certain of is that our broader strategy of products that are in and around the house, garden to garage, is where the functioning part of the U.S. economy is likely to continue to not just function, but to benefit from the trends that are going on.
Great.
The commodity side, Brian?
Yeah, sure. To address your commodity question, sure, we saw some changes in commodities over the last 60 days or so. However, we also have increased costs related to COVID itself with the testing at the facilities and the cleaning, not to mention the appreciation awards. Overall, our cost structure is up, not down.
Okay. Thank you.
The next question is from Julio Romero of Sidoti & Company. Please go ahead.
Hey, good afternoon. Hope you folks are doing well.
You too, Julio.
Hello. Wanted to start on CPP. You had mentioned all your facilities minus the U.K. and Mexico are operational. Can you discuss the utilization rates? Are you having reduced hours, reduced shifts? Any color there would help.
Sure. The facilities are operating. They're fulfilling and seeing normal orders. We do have some shifts in the way we operate the facilities to enhance social distancing, but the facilities are really fully operational.
Okay. That's helpful. On Home and Building Products, just thinking about the sales process there with installers having to enter the home, I would believe. Would that lend itself to elevated risk there? What do margins look like in Home and Building Products, assuming that volume decline you may be seeing there?
For selling residential garage doors, actually, you don't need much interaction at all. They don't go inside your house.
Yeah. That's an outside the house.
Outside of the garage. Right. Also, particularly through our dealers, they have software, it's called MyDoor, that they can deal with customers at a distance, online or through the online portal to design the door, showing a picture of the house, showing what the door will look like. Nobody needs to interact with anybody directly. They can give their credit cards, and they'll show up at the house, install it. You don't have to get anywhere near them. That whole process is fully operational.
Okay. Ron, did I hear you say in your prepared remarks that about half of your CapEx is maintenance? I guess, would that be about $30 million or so?
You did.
Yeah. I'll take that one.
Sure.
Generally, our CapEx runs about 50-50, in terms of maintenance versus investment or business expansion. This year, we have CapEx out there of $60 million in guidance. $15 million of that is related to the AIM initiative. I would say the balance there after that is roughly 50-50. If that's helpful.
Got it. Okay. Understood, yep. Thanks for taking the questions and stay healthy.
You too.
Thank you.
The next question is from Justin Bergner of G Research. Please go ahead.
Good afternoon, Ron. Good afternoon, Brian.
Hi, Justin.
Hey, Justin.
Had two clarification questions to start to make sure I heard your comments correctly. Could you repeat what the revolver availability, or I guess unused portion of the revolver was at March 31st?
At March 31st, we had $195 million available under the revolver. In addition to that, we do have a $100 million accordion feature in our credit facility. I would also like to add, right now, at the end of March, we're at our peak working capital point of the year. As April comes in, our cash generation cycle begins and goes right through the end of our fiscal year, and we expect strong free cash flow through the end of the year, which will reduce the revolver balance.
Understood. What is the leverage ratio covenant that you need to be mindful of for that revolver?
Currently, we're at 6.25, is the covenant, and our actual is 5.1 at our peak.
Okay.
It's 5.1.
I'll remind you, there's another $100 million of a revolver of accordion.
Okay. The second just comment I wanted to clarify, the down 15%-20% April, that was specific to residential garage doors?
Correct. We were seeing in the residential side of the Clopay business, a 15%-20% decline of orders in the month of April. Generally, that was coming out of the retail sector. As you could imagine, people are not going into Home Depot, standing in an aisle for very long to order a garage door. We see our dealer network being pretty strong and not much degradation there at all.
Okay. That makes sense. Any comment on how consumer professional products trended in April?
Sure. We actually saw in the U.S., or North America, I should say, and Australia, steady normal volume. Good volume throughout that period. Of course, U.K. is not operating right now, so, that's the only exception in that business. We expect the U.K. to be operational in early July.
Okay. you're talking about demand there, not just production.
I'm talking about demand, in what I just said. Production is normal as well.
Okay. Great. That's good. Oh, sorry.
No, go ahead.
I guess my last question was, in terms of the CARES Act benefits, the $10 million this fiscal year and the $5 billion next fiscal year, could you maybe just give us a little clarity as to where those benefits come through?
Sure. There are many benefits related in the CARES Act. I don't want to go through all the potentials, but right now what we see is the benefit from deferring employer portion of Social Security. The rule works that you could defer those payments through the end of the calendar year. For us, it'll be Q3 and Q4 this year and Q1 fiscal 2021, and that's $10 million in fiscal 2020 and $5 million in fiscal 2021 benefit that we expect to see. That is repayable by December, 50% in the next two years in December of each of those years. Doing the math, that'd be $7.5 million in December of 2021 and $7.5 million in December of 2022.
Okay, thanks. I'll hop back in the queue.
As a reminder, it is star one to ask a question. The next question is from Timothy Wojs of Baird. Please go ahead.
Hey, everybody. Good afternoon. Hope you guys are safe.
You too. How you doing, Tim?
Hi, Tim.
Good. Thank you. I guess just a couple of follow-up questions from me. How would you think, relative to normal, how would you think about working capital in the back half of the year relative to production if you do see volume weakness kind of persist through the summer and into the back half of the year? I guess, how would you manage that relative to normal and maybe relative to a down cycle?
Sure. We have adjusted already some of our shifts, particularly in the residential door facility, to accommodate the fact that we have less volume. We'll continue to watch our working capital. We'll continue to watch our collections. We will adjust our business, accordingly, based on demand that we see in the coming months.
Okay. Would it be fair that you would normally release working capital from inventory in this lower demand environment?
Yes, correct.
Okay. Gotcha.
We'll naturally see working capital decrease in the H2 of our year per our normal cycle. In addition, i f sales decrease, we'll see additional working capital generally come out of the balance sheet, come down from the balance sheet.
Okay. That makes sense. In the U.S. businesses, price mix was still relatively solid in the Q2. Just with, I guess, a more uncertain consumer, how would you think about that over the next few quarters? Have you seen any changes in mix through any of the various U.S. businesses thus far in April?
Sure. It's actually a little difficult to project what that would be. I can give you some anecdotal items. In our garage door business, generally, we see better mix out of our dealers than we do out of the retail channel. On our inside, I don't anticipate really any change in mix that I could foresee anyway.
Okay. The last one, just in the residential garage door business, how much would you estimate is break-fix versus some sort of discretionary replacement?
It's very difficult to estimate exactly. What we do see generally is the businesses by far more repair on the model than it is new construction. Generally, that will be resistant to downturns as people have a regular cycle of replacing doors.
Okay. Sounds good. Thanks for the time. Good luck on the back half of the year, guys.
Thanks.
Thank you.
Next is a follow-up question from Justin Bergner of G Research. Please go ahead.
Oh, thank you again. Two follow-ups here. I guess you mentioned in the press release defense proposal costs. Are those going to continue for a while? Any sort of, I guess, clarification on the magnitude of those costs and what they're associated with?
Sure. They are exactly as their name bidding proposal costs. We have seen very good activity, and we have a lot of opportunities in front of us that we are bidding on. We don't expect the cost to really be outside necessary for the H2 of the year as a lot of that work has already occurred. We will continue to go after the business that's before us, and we do have a very strong pipeline.
Okay. That's helpful. Those costs, though, weren't related to the Lockheed Martin India contract. Those were different opportunities you were going after?
Generally different opportunities, correct.
Okay. The second question on defense was a little bit bigger picture. Obviously, the company operates at high leverage for the most part, has during its lifetime. If the recession gets difficult, would the company consider different strategic options for the defense business? How does the political uncertainty potentially alter how you think about the long-term place for defense in the portfolio?
We've owned Telephonics for a very long time. We're very comfortable with its strategic plan. We see near-term growth in its backlog. It is a core asset, and we're very excited about what we see going on for its future.
Okay, great. Thank you for the follow-up.
This concludes the question- and- answer session. I would like to turn the floor back over to Ron Kramer, Chief Executive Officer, for closing comments.
Well, we've been able to make it through these incredibly turbulent times. We believe we continue to be well-positioned. I'm very confident and optimistic about what's going on within the company, and very excited about our future. To everybody on the call, I hope you're all safe, healthy, and we look forward to speaking to you again after the end of this quarter. Thank you and goodbye.