Essendant (NASDAQ:ESND) Q2 2018 Earnings Conference Call July 27, 2018 8:30 AM ET
Executives
Richard Phillips – President and Chief Executive Officer
Janet Zelenka – Senior Vice President and Chief Financial Officer
Analysts
Chris McGinnis – Sidoti & Company
Operator
Good morning, ladies and gentlemen, and welcome to Essendant’s Second Quarter 2018 Earnings Conference Call. My name is William, and I will be your conference coordinator for today. Your hosts are Mr. Ric Phillips, President and Chief Executive Officer; and Ms. Janet Zelenka, Chief Financial Officer.
All participants will be in listen only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. And please note that today’s event is being recorded.
Before we begin, the management team of Essendant have asked me to remind you that information shared on this call may include forward-looking statements. Forward-looking statements involve significant risks and uncertainties and events or results could differ materially from those discussed today.
Information concerning these risks and the factors that could cause actual results to differ from the forward-looking statements information we provide today can be found in our form 10K, form 10-Q and other filings with the Securities and Exchange Commission, including those relating to our pending merger with Genuine Parts Company’s SP Richards business. These filings are available at SEC.gov.
Essendant’s second quarter news release along with the financial slide presentation and other information relating to this call can be found on the investors section of the Company’s website at investors.essendant.com. This conference call is being webcast live on our website and a replay will be made available after the call.
I would now like to turn the call over to Mr. Ric Phillips. Please go ahead, sir.
Richard Phillips
Thank you, William. Good morning, everyone, and thanks to all of you for joining us. Our team is at Essendant has been hard at work over the past few quarter to execute against our strategic drivers in order to reduce cost, drive sales and leverage our network and capabilities to partner with suppliers. I’m pleased that our quarterly results are beginning to reflect the impact of that hard work on our performance and trajectory.
On this call, I’ll provide a recap of our second quarter performance and given an update on the progress we’ve made on our strategic drivers. I’ll also provide a brief update on the S.P. Richards transaction and the unsolicited proposal we received from Staples before I hand it over to Janet for additional details on our results.
Second quarter sales declined slightly by 0.5% or $6.4 million versus prior year, as growth in our key channels largely offset the national reseller channel sales decline, which we’ve talked about in prior quarters. The improvement in the sales trend from prior quarters coupled with the impact of our cost improvement efforts resulted in second quarter adjusted earnings per share of $0.16. This included around $0.09 per share related to a reduction in a receivables reserve for one customer. Adjusting for that one time benefit, our results remained in line with our expectations for the quarter.
Turning to our key strategic drivers, we are focused on three areas as we’ve communicated previously. One, improving efficiency across our distribution network and reducing our cost base. Two, accelerating sales performance in key channels. And three, advancing supplier partnerships that leverage our network and capabilities.
Our first strategic driver includes a complete redesign of our inbound freight logistics, consolidation within our distribution network, and operating cost reductions. Our inbound freight consolidation plan is expected to generate significant value in 2018 and beyond. With all four of our new inbound consolidation centers now open, we are focused on optimizing and improving center utilization, adding support for new analytic processes, and working with suppliers to improve overall efficiency across the supply chain. We are also optimizing our distribution network footprint.
As planned, this year we have consolidated nine distribution centers across the U.S. As we consolidate, we are taking care to monitor customer experience and quickly address any impacts.
In addition, we are realizing the benefits of our comprehensive plan to optimize costs and drive efficiencies. Our reorganized and streamlining teams are maintaining customer centric approach and quickly implementing meaningful process improvements. We will continue to realize benefits through 2018 as they scale through the second half of the year.
Turning to our second driver. Our efforts to accelerate growth across key sales channels and customers are also producing strong results. We continue to see growth in our JanSan distributors, vertical markets, industrial, and automotive channels, as well as with several key customers including independent reseller partners and e-commerce resellers. Our commercial teams are working to expand product offerings to our customers across traditional channel lines and partner with our customers to win market share. Overall, I am pleased with our efforts and the positive sales momentum we continue to generate.
To further drive that momentum, in the second quarter, we invested $19 million in the independent resellers’ channel. We believe in the value proposition that independent retailers provide to their customers and we have invested in the independent reseller channel in several ways over the years including digital capabilities and content, catalogs, rebate programs and logistic support services. As we execute against our strategic drivers, we are now engaging in more strategic investments in this channel.
With these investments, independent resellers will continue to operate independently and provide local customer service and business support to their customers, while leveraging ascendance infrastructure, products and digital solutions.
Finally, our work on our third driver, advancing supplier partnerships continues to progress as we’ve collaborated with our preferred suppliers to develop successful market strategies and deep in customer insights through advanced digital analytics. Our restructuring program is on target with expectations. Across functional team skillfully drove the program to allow us to capture the cost reductions associated with our strategic drivers to improve organizational alignment around our growth channels and to provide the product assortment capacity to invest in additional products with our key suppliers’ overtime.
As previously shared, we expect to realize over $50 million of annualized cost savings by 2020 with more than half of that realized in 2018, helping to offset the earnings impact of the year-over-year sales decline with national resellers. We continue to progress in our strategic drivers and we expect to see the benefits including cost reductions and sales growth in key channel continue throughout the year.
Before I turn it over to Janet, I’d like to share some updates on our merger with S.P. Richards. As you may have seen, last week, we filed an amended S-4 with the Securities and Exchange Commission in connection with our proposed merger with GPC’s S.P. Richards business. We are working with the SEC to finalize the S-4. After the registration statement is declared affected by the SEC, we will mail notice of the shareholder meeting. We are also working to comply with the Federal Trade Commission’s request for additional information. We continue to expect the transaction to close by the end of the year. And our Board of Directors’ recommendation that shareholders vote in favor of the transaction remains in place.
Separately, we received a Civil Investigative Demand or CID from the FTC in connection with Staples Hart-Scott-Rodino filing regarding its unsolicited proposal to acquire Essendant. Staples have not entered into a confidentiality agreement with Essendant and we have not engaged in discussions with Staples regarding their proposal.
I’ll now turn the call over to Janet to provide more details on our second quarter results and our outlook for 2018. I look forward to sharing additional updates over the coming quarters.
Janet Zelenka
Thank you, Rick. I’d like to start off with a few remarks on our overall performance in the second quarter and then provide updates on our initiatives as well as our outlook for the remainder of 2018.
Beginning with the overview of our second quarter results on Slide 5, our GAAP results were $0.00 per share. This included $0.5 million of favorability and cost associated with the restructuring program we kicked off in the first quarter, which I’ll walk through in a few minutes. It also included $9.9 million of transformation expenses, primarily related to transaction costs for the S.P. Richards merger. Excluding these items, our second quarter adjusted earnings per share were $0.16, up $0.28 from the first quarter. This reflects a reduction in a receivables reserve for one customer, a one-time benefit of approximately $0.09. The adjusted results also reflect improved sales during the second quarter and our continued cost improvement efforts.
As Rick mentioned, the restructuring program we launched in the first quarter to support our strategic drivers is on track. The program includes cash cost for facility consolidations and workforce reductions and non-cash costs related to the refinement of our product assortment to address items that have low sales and limited availability.
In the second quarter, we incurred $8 million in cash costs and we reduced our product assortment non-cash reserve by $8.6 million, as our team generated better than expected recovery on the product rationalization. As a result of our overall cost savings initiatives and the restructuring program, we remain on track to deliver an analyze run rate of cost savings over $50 million in 2020 with more than half of those savings realized this year. I will focus on adjusted results for the remainder of my comments.
Second quarter net sales decrease 0.5% or $6.4 million versus prior year. Sales growth in key channels and customers largely offset the continued wrap of the sales decline in the national reseller channel.
Turning to Slide 6. I want to focus on some highlights in the second quarter sales by product category. Our industrial product category remained strong, up 11.6% versus prior year. Cut sheet paper was up 5.8%, driven by increased purchasing of domestically sourced paper by the independent reseller channel. Our automotive product category was up 4%, due to the team’s effective use of new promotional approaches. The JanSan product category was down 1%, as growth with JanSan independent resellers largely offset the sales decline with national resellers. Furniture, office products and technology products were impacted by sales declines in the national reseller channel as well. Although sales growth among our key channels and customers have help mitigate some of the year-over-year impact.
Adjusted gross margin dollars in the second quarter were down $12.9 million to a $164.7 million. This was primarily due to freight costs driven by carrier rate increases and fuel inflation, sales channel mix impact and a shift in products sales to categories with lower supplier allowance rates and fewer opportunistic inventory purchases.
Adjusted operating expenses for the second quarter were $146.7 million, favorable by $5.8 million to second quarter 2017. This favorability includes a $5.1 million reduction in the receivables reserve for one customer. We continue to manage labor costs and execute other cost saving initiatives.
Turning to the balance sheet on Slide 7. Inventory levels increased $79 million in the first half. On a borrowing base of over$1 billion, our debt levels increased $26 million over year end to $530.2 million as of June 30, which reflects a reduction in debt of $12.1 million during the second quarter. Our remaining availability under our credit agreement was over $460 million. Our free cash flow was $37.2 million in the second quarter and $7.9 million in the first six months, including $4.5 million of year-to-date transaction costs related to the S.P. Richards merger.
As Rick mentioned, we have invested one $19 million in the independent reseller channel in the second quarter, which is excluded from our calculation of free cash flow.
Moving on to our outlook for the remainder of 2018. We have adjusted our range of full year sales decline to down 1% to down 3% from the prior year, as compared to the down 3% to down 5% range we discussed last quarter to reflect the sales growth momentum from our strategic drivers.
As previously communicated, adjusted deluded EPS in the second half of 2018 is expected to be better than the first half of 2018. In addition, we expect it to be better than the second half of 2017 as our cost improvement efforts will continue to scale through the year.
We continue to anticipate that the business incorporating the cost and benefits of restructuring will generate free cash flow an excess of $40 million. This guidance excludes transaction costs, which as disclosed in our From S-4 filing with the SEC, we anticipate to be approximately $40 with about $25 million of the $40 million payable up on closing.
I would like to echo Ric’s comments and acknowledging the dedication efforts of our team, our strong progress on the strategic drivers as reflected in the second quarter results and we are focused on continuing to improve the value of our business.
Thank you again. And with that let’s open it up for questions.
Question-and-Answer Session
Operator
And we will now begin the question-and-answer session. [Operator Instructions] And our first questioner will be Chris McGinnis with Sidoti & Company. Please go ahead.
Chris McGinnis
Good morning. Thanks for taking my questions.
Richard Phillips
Good morning.
Janet Zelenka
Good morning, Chris.
Chris McGinnis
When you are starting the plan and nice job on result. Can you just maybe talk a little bit about what’s driving some of the strength especially in that industrial market? And then maybe – I guess you just start that and then I’ll go through some other ones as well.
Richard Phillips
Sure Chris. And thanks again for joining the call this morning. I’d be happy to talk about that. On the topline, we are continuing to see momentum in the channels that we are really focused on growing and we feel like we are well positioned. And that does include industrial as you mentioned also includes our JanSan distributors vertical markets and automotive channels among others. And also some key independent customers that are having success.
In industrial specifically, each of our businesses is demonstration positive now. ORS Nasco industrial business are MEDCO, automotive business and our CPO Commerce business. I think we’re seeing some favorable market trends, but we’re also seeing I think the effect of some of the commercial alignment that we’ve done. We’ve really worked to focus particularly in the ORS business on those customers where we feel like we have the best opportunity to grow and so we’ve realigned our sales teams in order to do that. We’ve realigned our inside sales model to support them as well. And we’re seeing strong results from what we’re doing there. So we feel good about the momentum overall that we’re generating across our growth opportunity channels.
Chris McGinnis
Great. And so touch on one you mentioned on the JanSan, how much was the impact and I guess if you back out the national accounts, how much were the independents maybe up, if you could just provide a little color that way?
Richard Phillips
We haven’t disclosed the specific breakdown there, but we saw a positive impact across those independents and we have a particular group of some of the larger customers that we call strategic, JanSan strategic and we’re seeing really strong growth with that channel. They really are taking advantage of our capabilities as we brought our platform solution to them, broaden our assortment over time and we’re seeing some good momentum there. We did have some benefit as we talked about in JanSan from the cold and flu season, but we also have good strength underlying that. And we do anticipate overtime to achieve above market growth in JanSan.
Chris McGinnis
Okay. Can you just maybe comment on e-commerce for you and how that grow in the quarter itself, if you did say that, I might have missed it.
Richard Phillips
No problem Chris. Our overall e-tail sales that do remain soft. It’s really primarily driven by downturn with one customer, which we’ve talked about previously. We are working closely with that customer in order to return to growth with them. And outside of that we are demonstrating strong growth with other customers in the e-tail channel.
Chris McGinnis
Great. Maybe just changing gears a little bit. Is that $19 million investment with the independent, can you maybe just talk a little bit about what’s behind that, is that more of a digital offering you know maybe just dive into that investment a little bit more?
Richard Phillips
Sure. Sure. we’ve really invested you know as we’ve talked about over the years in many different ways in the independent reseller channel, you know it does include digital capabilities and content, catalog, logistic support, rebate programs et cetera. The $19 million that we disclosed is a strategic investment which is another way that we believe we can collaborate with resellers to help them. Those retailers will continue to operate independently, but they’ll be able to leverage ascendants infrastructure scale and breathe of products as well as our digital solutions.
Chris McGinnis
Okay. And then maybe just touching quickly and I’ll jump in queue after this. Just with Staples no communication even though the FTC reached out here. I mean is that – I guess just your feelings there and what’s happening, can you dig a little bit into that?
Richard Phillips
Sure. We have not entered into a confidentiality agreement with Staples. And so you know therefore we have not engaged with them on their proposal. To your point, we give receive CID from the FTC in connection with Staples filing and we will comply with that request with the FTC.
Chris McGinnis
Okay. And that’s around this more information, is that correct?
Richard Phillips
Yes, our understanding is that Staples received a second request and we in turn received the CID.
Chris McGinnis
Okay, great. I’ll jump back in queue, but I still have some more questions, so. Thanks.
Richard Phillips
Okay.
Operator
[Operator Instructions] And our next question will be a follow-up from Chris McGinnis with Sidoti & Company. Please go ahead.
Chris McGinnis
Thanks again. I actually wanted to give to somebody. Can you maybe just speak about the margin structure where it’s today versus historically and maybe the opportunities, you know obviously that should start to get stronger, the initiatives you know scale as you say in the second half but I guess just thinking about the gross margin of these levels, is that kind state seemingly now or can you maybe just talk a little bit broadly about that? Thank you.
Janet Zelenka
Hi Chris, it’s Janet. Let me talk a little bit about the factors that impacted gross margin in this quarter. So it was primarily impacted by freight costs which were driven by some carrier rate increases and fuel inflation which you are seen across some of the earnings reports that are coming out. But we also have the ongoing sales mix impact on the products with cut sheet paper being a growth that is a lower margin product. And that’s mix in sales, also creates a mix in the supplier allowances as we ship the categories with lower allowance rate. So a lot of our efforts on the cost side could cost hit margin as well is to try to counter that that but that is a continuing trend we’re seeing in the business.
Chris McGinnis
Okay. So it seems like somewhat be the level for a while and so maybe you know maybe get some refund on the freight cost I guess?
Janet Zelenka
So we are you know actively look for ways to improve our freight position. As you know we are doing the inbound consolidation transformation and that is one way to improve our cost profile of our over overall freight programs.
Chris McGinnis
Well, thank you for answering my question, saying good luck in Q3.
Richard Phillips
Thanks a lot Chris.
Janet Zelenka
Thank you, Chris.
Operator
And this will conclude our question-and-answer session. I would now like to turn the conference back over to Ric Phillips for his closing remarks.
Richard Phillips
Thanks William and thanks to all of you for joining us this morning. I’m encouraged that our second quarter results reflect anticipated sales growth in key channel beginning to offset the year-over-year sales decline in the national reseller channel, as well as progress on our cost improvement efforts. We continue to execute on our strategic drivers and our associates are focused on driving performance in an evolving industry and improving the value of our business for our customers, our shareholders and our communities. We appreciate your time and interest during the call today and we look forward to sharing our progress with you in the coming quarters.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.
Be the first to comment