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Select Interior Concepts, Inc (NASDAQ:SIC)
Q4 2019 Earnings Call
Mar 12, 2020, 9:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Select Interior Concepts 2019 Fourth Quarter Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] I would now like to turn the call over to your host, Mr. Nadeem Moiz, CFO. Thank you, and you may begin Mr. Moiz.

Nadeem Moiz -- Chief Financial Officer

Thank you, operator. Good morning, everyone, and welcome to our fourth quarter 2019 financial results conference call. Joining me on the call today is Ty Johnson, our Chief Executive Officer. During our discussion today, we'll be referring to our earnings presentation, which is available on the Investors section of our website.

I will start with Slide 2, where I'd like to remind everyone that any forward-looking statements contained in this presentation or commented on today are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially because of issues and unknowns that need to be considered in evaluating our financial outlook and operating performance.

Please see our recent SEC filings, which identify the principal risks and unknowns that could affect future performance. We assume no obligation to update publicly any forward-looking statements. Specific conditions, issues and unknown factors that may represent forward-looking statements are noted in detail on the slide.

In addition, we will be discussing or providing certain non-GAAP financial measures today, including adjusted EBITDA and adjusted EBITDA margins. Please see the appendix for a reconciliation of these non-GAAP measures to their most directly comparable GAAP measure.

I would now like to turn the call over to Ty Johnson.

Tyrone Johnson -- Chief Executive Officer

Thanks, Nadeem. Good morning, everyone, and thank you for joining us today. I will begin on Slide 3 with a brief business update. Nadeem will follow with a review of our financials.

2019 was a year of strong growth and process improvement as we navigated shifting market dynamics. We focused on strengthening our platform to reach further into the sizable addressable market in both our installation and distribution businesses. We continue to execute our multi-faceted strategy to grow faster than our markets, cross-sell products and integrate acquired businesses.

We had some significant accomplishments for 2019, which I would like to mention. We achieved record full-year results. This includes net sales up 25% to $610 million, gross profit grew 23% to $164 million and adjusted EBITDA increased to $60 million. We were especially pleased to convert a more significant amount of adjusted EBITDA into operating cash flow, which totaled $31 million for the year and $11 million for the quarter. Lean initiatives and working capital management helped to drive this improvement and remain among our top priorities.

Turning to Slide 4. For the year, we posted record sales in both our installation and distribution businesses. That growth was mainly first-half weighted. Previously disclosed market pressures within our RDS segment and supply chain changes in our ASG segment adversely impacted our operating results during the second half of 2019. I will take a moment to discuss the impact of these dynamics on fourth quarter results, and more importantly I will provide some details on steps we have taken to solidify our positions in each business, given changing market dynamics.

At RDS, we grew sales 32% in the fourth quarter primarily through geographic diversification of this business into several new regions over the past year. Organic sales were relatively flat during the quarter with stronger volume in nearly all-served markets, particularly in Northern California, Phoenix and the Mid-Atlantic. We were pleased to receive 2019 best-in-class awards for our services performed for builders, including Toll Brothers, Terry Homes [Phonetic] and Lennar.

Similar to trends seen earlier in the year, RDS price/mix has been adversely impacted by the increasing shift of builders to entry- to mid-level homes as well as the build-to-rent market. This means smaller homes are being built at lower price points, with fewer options and upgrades. So, while our unit volume is up, we are seeing less installed product per home and in many cases, fewer upgrades. This dynamic is evident across our footprint though most pronounced in our Southern California market, which we have disclosed in the past.

In response to this rapidly evolving environment, we have strengthened our sales teams and reallocated resources to help drive market share as projects come up for bid. We are adjusting our product offerings and lockstep with the growing share of new communities that target entry-level and mid-priced homes. We have put in place new leadership at several divisions to improve operations, efficiencies and cross-selling capabilities. In addition, we have invested in proprietary product selection technology that the builder can customize to offer a tailored design experience to homebuyers with or without physically staffed showrooms.

We also believe this tool will enable builders to decrease their construction cycle times by reducing time spent by homebuyers selecting options and upgrades. We have recently rolled this tool out in several markets and it has already resulted in new customer relationships. The feedback has been very positive, and we believe this tool to be a competitive differentiator. We are very excited by the prospects for this new technology.

In our ASG segment, let me first say that the challenges associated with our supply chain disruption that we discussed last quarter were largely resolved by year-end. As a reminder, ahead of expanded U.S. tariffs on quartz imports, during early 2019, we entered into new partnerships with additional global suppliers that resulted in some initial inefficiencies. We are pleased with the hard work of our team to streamline processes and return cost to normalized levels.

During the fourth quarter, most of our product lines performed well within a relatively competitive environment. The decline in volume was primarily attributable to one high-end quartz product line formerly supplied by a Chinese partner. The reproduction of certain high-end visuals by our new suppliers has been harder to replicate than initially anticipated. We believe this to be an industrywide dynamic, whereby certain products formerly purchased from China have proven difficult to source from new partners.

We are taking several actions to improve our operations as well as our market positioning. We are trimming costs, improving processes and leveraging technology to simplify the business. We plan to introduce several new quartz and porcelain product lines throughout the year. Beyond countertops, we are reenergizing our tile lines with six new product launches later this year.

Overall, as we entered the new year, we are encouraged by the improving homebuilding landscape and remain focused on continuing to drive efficiencies throughout the business. We will maintain our focus on delivering best-in-class service to our customers as we execute our product, channel and geographic diversification strategy. We are committed to generating improvements across all areas of our growing business and rightsizing our structure.

The ERP implementation in RDS is complete, and the last several branches at ASG will be complete within the next few months. These ERP implementations provide us enhanced control over labor, product and sourcing management, as well as better visibility on market demand and individual project costs.

Before concluding my remarks, I wanted to take a few moments to speak about the coronavirus. We are committed to the health and well-being of our employees, their families and the communities in which we operate, while at the same time continuing to service our customers. We are mindful of the potential impact associated with this situation and are taking recent developments very seriously and are monitoring the situation continuously. We are in regular contact with our customers and suppliers and have not seen meaningful impact to the business at this time.

We have created a cross-functional response team to oversee the issue and its potential impact to our operations and employees. Our goal is to strike the right balance between public health and what's required to manage our business and take care of our employees and customers. We are in the early stages of a very attractive market opportunity and remain confident in our ability to continue to drive improvements within our business, solidify our premier market positions and generate attractive returns for our shareholders.

Once again, thank you for joining. And with that, I will turn the call over Nadeem.

Nadeem Moiz -- Chief Financial Officer

Thank you, Ty, and once again, good morning, everyone. Moving to Slide 5 for a review of net sales. Fourth quarter net sales increased $22.3 million or 16.8% to $155.2 million compared to prior year.

Looking at our segments. In our RDS segment, sales growth of 31.5% was driven primarily by acquisitions. Organic volume was stronger across the RDS footprint, including our design and installation business in Southern California. This volume growth was mostly offset by pricing pressures resulting from the shift toward more entry- to mid-level homes, which is consistent with the direction of the market.

In ASG, sales declined 2.9%, driven primarily by lower volume, as Ty covered earlier. ASG did not have any contributions from acquisitions in the fourth quarter.

Moving to Slide 6. In the fourth quarter, reported EBITDA increased to $12.1 million from $8.7 million in the prior-year quarter. Adjusted EBITDA was $13.7 million compared to $14.9 million in the prior year. Acquisitions were margin accretive and added $2.9 million to adjusted EBITDA. The $3.8 million decline in organic flow-through to adjusted EBITDA is primarily a result of the mix shift we experienced in RDS.

On Slide 7, net sales for the full-year 2019 improved 24.6% to $610.4 million compared to last year. Acquisitions completed during 2018 and 2019 drove 22.9% growth. The remaining organic increase of 1.8% was driven by 5.8% expansion in ASG and offset by 1.5% reduction in RDS. Full-year adjusted EBITDA increased to $60 million, up 10% compared to prior year. Incremental EBITDA of $15.4 million from acquisitions was partially offset by $3.5 million of unfavorable mix impact, again primarily in RDS, and $6.4 million of other costs reflecting full-year impact of corporate costs and expansion-related investment in RDS and ASG.

Moving to Slide 8. During 2019, we generated cash flow from operations of $31 million, which increased significantly compared to $12.2 million in the prior year. We converted just over half of our adjusted EBITDA into cash flow from operations through improved working capital management, tax planning initiatives and a lower interest rate.

Into 2020, we're optimistic about our prospects to grow our business and generate cash flow for the full year. As Ty discussed, we have a range of initiatives in play to improve performance in both segments. Keep in mind, in RDS, a shift to more entry- to mid-level homes is expected to continue. In ASG, we're continuing to manage our diversified global supply chain and our exciting new product launches of high-end quartz products. Our actions to mitigate mix shifts in the market include continued vigilant management of costs and cash flow into 2020.

Our recently implemented ERP in RDS will enable higher productivity levels and tighter project cost management. Our investment in the implemented proprietary product selection technology in RDS will allow us to better serve all our builder customers at various price points. Our ERP investment and rollout in ASG is also expected to drive back-office integration and network efficiencies in that segment.

Given that our technology implementation for the most part is complete, we have line of sight on the efficiencies, and we expect the benefits to be more impactful as we move later into the year. We will look forward to further building on our 2019 progress as a leading installer and distributor of high-end interior product in 2020 and coming years.

And operator, we would like to open up for Q&A at this point.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Alex Rygiel from B. Riley FBR. Please proceed with your questions.

Alex Rygiel -- B. Riley FBR -- Analyst

Thank you. Good morning, gentlemen.

Tyrone Johnson -- Chief Executive Officer

Good morning.

Nadeem Moiz -- Chief Financial Officer

Good morning, Alex.

Alex Rygiel -- B. Riley FBR -- Analyst

Few quick questions here. First, operating cash flow of $11 million in the quarter, $31 million for the year that was nicely solid. Can you comment on your outlook for 2020? And then comment on how you think about operating cash flow longer term with this business model?

Nadeem Moiz -- Chief Financial Officer

Absolutely. Alex, this Nadeem. Look, we're very happy with our performance on cash flow in 2019 and the fourth quarter obviously. This -- the business has a very strong cash flow profile. As you could see, the EBITDA conversion into cash was extremely high. It's almost 80% in the fourth quarter and roughly 50% for the full year. There is some seasonality in the cash flow, it's sort of second half fourth quarter based on the way the building cycle works. And as we think about cash flow component, certainly the strong EBITDA that we generated in 2019, we expect that to continue.

Working capital will continue to be tightly managed and even more so than we did in 2019 as the ERP systems come online. Our capex requirements, as you've seen, are fairly limited and very much focused on growth initiatives in the past. Maintenance capital is very, very low in the business. And so that's a very nice profile for us to have. And we launched a number of tax planning initiatives in 2019, which benefited us in 2019 and we'll have some additional initiatives in 2020.

So overall, the way you think about this is a high cash flow conversion sort of in that 80-ish percent rate. That's the way we like to think about it. And as we sort of model forward, that's -- that would be good. We're thinking about it.

Alex Rygiel -- B. Riley FBR -- Analyst

Helpful. Secondly, homebuilder backlog is up real strong. New home construction starts data for the last seven months has been trending nicely positive. How should we think about that backlog build? And how and when it starts to sort of come through your P&L over the next couple of quarters? And then if you could also blend into that answer a comment on the mix in your backlog and how that might be different than maybe a year ago?

Tyrone Johnson -- Chief Executive Officer

Sure, Alex. Happy to help you with that question. So, our backlog remains very, very strong, even in Southern California where we've had some of the more severe mix shifts. The backlog continues to grow in every single one of our territories, so we're happy about that. The issue rightfully noted into the mix -- in the backlog mix is changing, it's really just a function of the homes that are builders are building. And as you well know, builders are now building disproportionately at the lower-to-mid price point. And as a result, that's where the opportunities exist for the RDS business.

So while the backlog continues to remain strong, the profile of the homes within the backlog are different than they were this time last year, given the focus on entry-level and mid-priced homes.

Alex Rygiel -- B. Riley FBR -- Analyst

And then lastly, you talked many different times through your prepared remarks about focus on cost and cost control and reducing costs. As it relates to gross margin, how should we think about those cost reductions affecting gross margin in 2020 versus 2019? And then as we think about SG&A, on an absolute basis, has SG&A sort of topped out here and should we expect SG&A to start to decline from these efficiency opportunities? Any comments there would be helpful.

Nadeem Moiz -- Chief Financial Officer

Yeah, absolutely. And so on the gross margins, we would expect the gross margins for 2020 to be sort of in line with the 2019 gross margin in the business, because you've got really two things going on. We've got the mix shift happening in RDS and offset by efficiencies and cost reductions that we're pushing through, with respect to the ERP implementation. And then ASG, there is -- we talked a little bit about the product, new product changes. So, we'll be launching those new products and continue to make investments in ASG growth, which was great in 2019.

So, I would say, look, we will have marginal improvement in these -- in the gross margins, which is exactly what we're targeting. We've talked about 20 basis points to 40 basis points increase on a year-over-year basis in the past. So, we're still feeling good about that. And that's the way I would think about that. The question around operating expense or SG&A, that we were expecting to get operating leverage as we consolidate the back-end in both these businesses. So the ERPs are separate, ASG has its own ERP, RDS has its own ERP. So we're expecting further integration in those verticals and efficiencies to be pushed through. And the idea was always a scalable platform. And so as we continue to grow and do greenfields and acquisitions, we think this platform is very, very scalable.

Alex Rygiel -- B. Riley FBR -- Analyst

And I do have one last question. Can you prioritize your use of free cash flow generation over the next 12 months in light of where your stock price is, what the broader market outlook looks like and so on?

Nadeem Moiz -- Chief Financial Officer

Yeah, absolutely. Look, it's a question around capital allocation. And we are definitely still in growth mode, right? So, we'll continue to be focused very much so on growth initiatives. We think there's a number of growth initiatives that we believe are very accretive. We are continuing to have our discussions internally as well on the other ideas, but definitely a big part of that discussion is going to be growth-oriented capital deployment.

Alex Rygiel -- B. Riley FBR -- Analyst

Thank you very much.

Operator

Our next question has come from the line of Keith Hughes of SunTrust Robinson Humphrey. Please proceed with your questions. Keith, could you check if your phone is on mute please?

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

I'm sorry. Can you hear me now?

Tyrone Johnson -- Chief Executive Officer

We could hear you, yes.

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

Okay. Sorry, I'm having some connection problem. Just real quick, the question is on ASG. The -- you talked about why the volume is down in the quarter. Are you seeing any impact from inventory build, given there has been a lot of tariffs in the products at ASG? So, is there inventory pressure in the channel right now?

Tyrone Johnson -- Chief Executive Officer

Keith, it's Ty. We think there is some, but we think it's easing. This time last year, there was much more pressure. So there is still some inventory build up there, but we think that's starting to make its way through. So to answer your question, there is some, but it's improving.

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

Okay. And the -- do you [Technical Issues] that you had a difficult time sourcing outside of China. Is that fixed or is that going to be a drag for future period?

Nadeem Moiz -- Chief Financial Officer

So Keith, you broke up a little bit. I think your question was with respect to the issues on sourcing outside of China, do we feel like the issues are behind us or whether or not they're going to persist for a while. Is that the question?

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

That's correct, yes.

Nadeem Moiz -- Chief Financial Officer

Yeah. So, we think we've made a lot of progress. There will still be a little bit of headwind associated with that as new products come online. But in terms of finding the right partners and finding product that meets the market's needs, we feel like we're there. It's just a function of getting that product sampled in the marketplace and display towers out and the sales force selling it. So that's where we are, but we feel a lot better today than we did many months ago about the actual performance of the suppliers and the ability to merchandise it.

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

Okay. And the margins at ASG actually were up year-over-year despite this disruption. Is that -- what does that driven from?

Tyrone Johnson -- Chief Executive Officer

One element is we had a number of price increases within ASG, particularly on some of the quartz lines and that was certainly helpful. And I think that probably be one of the larger components to why the margins are up.

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

Okay. And final question on RDS the -- is combating this mix down, which is probably going to be with us for a while. Is new products part of that or is this more just the cost new customer-type initiatives to deal with the situation?

Nadeem Moiz -- Chief Financial Officer

Well, new products are part of it, Keith, and so far it is being more important to your customers and creating more stickiness, adding more value, getting more overall share of the wallet. But we think in terms of the overall financial performance, it's really a cost structure improvement play. There is a lot of volume out there for sure. You're just not having the same square footage opportunity or the same upgrade opportunity as we've had in the past. So it's really incumbent upon us to rightsize the business to match the level of revenue and the margin associated with that revenue.

So, I think most of the work to kind of hold what we think to be a reasonable adjusted EBITDA margin needs to happen within the operation, and hence the ERP implementations and some of the process improvements. So, we're excited about the progress we're making, but there's still work to do there.

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

Okay. Thank you.

Nadeem Moiz -- Chief Financial Officer

Yeah, sure. You're welcome.

Operator

We have reached the end of the question-and-answer session. I will now turn the call back over to management for any closing remarks.

Nadeem Moiz -- Chief Financial Officer

Thank you, operator, and thank you, everyone, for joining us today. We appreciate your support, and we look forward to speaking with you again next quarter.

Operator

[Operator Closing Remarks]

Duration: 26 minutes

Call participants:

Nadeem Moiz -- Chief Financial Officer

Tyrone Johnson -- Chief Executive Officer

Alex Rygiel -- B. Riley FBR -- Analyst

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

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