Tracking John Paulson’s Paulson & Company Portfolio – Q1 2020 Update


This article is part of a series that provides an ongoing analysis of the changes made to John Paulson’s 13F stock portfolio on a quarterly basis. It is based on Paulson’s regulatory 13F Form filed on 05/15/2020. Please visit our Tracking John Paulson’s Paulson & Company Portfolio series to get an idea of his investment philosophy and our previous update for the fund’s moves during Q4 2019.

This quarter, Paulson’s 13F portfolio value decreased ~43% from $4.63B to $2.62B. There are 33 13F securities in the portfolio, although only 25 of them are significantly large equity holdings (more than 0.5% of the 13F portfolio). The article is focused on the larger holdings. The top five positions are Bausch Health, SPDR Gold Trust ETF, Horizon Therapeutics, Takeda Pharma, and AngloGold Ashanti, and they add up to ~47% of the portfolio.

John Paulson is best known for his highly leveraged bets against the real-estate bubble that netted him billions in the aftermath. To learn more about that, check out the book “The Greatest Trade Ever”.

Note: Paulson & Company is known to have a huge position in Fannie/Freddie (OTCQB:FNMA) (OTCQB:FMCC), although the details have not been disclosed.

Stake Disposals:

WellCare Health Plans (WCG): Centene (NYSE:CNC) acquired WellCare Health Plans in a cash-and-stock deal (3.38 shares of Centene and $120 cash for each share of Wellcare Health Plans held) that was announced last March. Paulson bought the merger-arbitrage stake in H1 2019 at prices between $247 and $299. The position was sold down by ~85% last quarter at prices between $258 and $333. The transaction closed in January.

Agnico Eagle Mines (AEM) and Caesars Entertainment (CZR): These small (less than ~1% of the portfolio each) stakes were eliminated this quarter.

New Stakes:

Kirkland Lake Gold (KL): KL is a small 1.69% of the portfolio position established at prices between $23 and $45 and the stock currently trades at $38.61.

Stake Decreases:

Allergan plc (AGN): The original AGN stake was built during the four quarters through Q2 2015 at prices between $202 and $313. In Q4 2015, there was an about-turn: ~75% selling over the next two years at prices between $192 and $320. H2 2018 also saw an ~18% selling at prices between $131 and $192. There was an about-turn in Q2 2019: ~45% stake increase at prices between $116 and $168. Next quarter saw another ~30% stake increase at prices between $156 and $170. Earlier this month, AbbVie (ABBV) closed the transaction for Allergan (cash-and-stock deal – $120.30 cash and 0.8660 shares of ABBV for each AGN held) announced last June.

SPDR Gold Trust ETF (GLD): A huge stake in GLD was established in Q1 2009 at prices between $83 and $98 and was reduced by ~45% in 2011 at much higher prices. It was reduced by more than half in Q2 2013 as well at prices between $116 and $155. Q4 2015 and the following quarter saw a combined ~60% reduction at prices between $100 and $122. This quarter saw another ~55% selling at prices between $138 and $158. The stock currently trades at ~$163. The remaining stake is still the second-largest at ~11% of the portfolio.

AngloGold Ashanti (AU): AU is a 7.20% position. It is a long-term stake that has been in the portfolio since 2009. Q4 2015 had seen a ~9% trimming while the following quarter saw a one-third reduction at prices between $7 and $14. Q2 2016 saw another ~20% reduction at prices between $13 and $18. The stock is currently at $25.45. This quarter also saw an ~11% trimming.

Discovery Inc. (DISCA): DISCA position saw a 320% stake increase in Q1 2018 at prices between $21.50 and $26.50. That was followed with a ~140% further increase next quarter at prices between $21 and $24. DISCA currently trades at $20.30 and the stake is now fairly large at 6.19% of the portfolio. This quarter saw a ~15% trimming.

Note: Liberty’s John Malone said in an interview last October that he believes Discovery shares are dramatically undervalued – he has been buying shares all the way from the teens to ~$28 per share.

TIM Participacoes (TSU): TSU is a 0.78% portfolio stake first purchased in Q2 2014 at prices between $24 and $30. The position had remained relatively steady since. Q1 2018 saw a ~10% selling at prices between $19.50 and $22.50. Q3 2019 also saw a ~25% selling at prices between $14 and $16.40. This quarter saw another ~55% selling at prices between $11.75 and $20. The stock is currently trading at $11.43.

Pretium Resources (PVG): PVG is a very small 0.52% of the portfolio stake purchased last quarter at prices between $8.70 and $12.50 and the stock currently trades near the low end of that range at $8.87. This quarter saw a ~7% trimming.

Sprint (S): Sprint was a 1.67% of the portfolio position built last year at prices between $5.20 and $8. It was a merger arbitrage stake. In January, the terms of the merger with T-Mobile (NASDAQ:TMUS) was adjusted: one share of T-Mobile for every 11 shares of Sprint compared to 9.75 shares agreed previously. The transaction closed last month.

Barrick Gold (GOLD) and Overseas Shipholding Group (OSG): These two very small (less than ~1% of the portfolio each) stakes were reduced this quarter.

Note: Paulson & Company has a ~7.3% ownership stake in Overseas Shipholding Group.

Stake Increases:

NovaGold (NG): NG is a 7.10% of the portfolio long-term stake established in 2010. Q2 2016 saw a ~28% reduction at prices between $5 and $6.50 and that was followed with a ~13% selling in Q4 2016. This quarter saw a ~15% stake increase at prices between $5.87 and $9.51. The stock is currently at $11.57.

Note: Paulson has a high cost-basis on NG and controls ~8% of the business.

Endo International plc (ENDP), Tech Data Corp. (TECD), and Tiffany & Co. (TIF): These positions saw substantial increases this quarter. TIF and TECD are merger-arbitrage stakes.

Kept Steady:

Bausch Health Companies (BHC) previously Valeant Pharmaceuticals: BHC position was increased by almost 300% in Q1 2015 at prices between $143 and $205 and another ~340% the following quarter at prices between $197 and $242. Q4 2015 also saw a ~50% increase at prices between $70 and $182. The aggressive buying against falling prices continued in Q2 2016: ~44% increase at prices between $19 and $36. The stock currently trades at $17.76 and the stake has become the largest position in the portfolio at 12.32%.

Note: Regulatory filings since the quarter ended show them owning 25.8M shares (7.28% of the business). This is compared to 20.84M shares in the 13F Report – ~5M shares acquired at ~$16.50. For investors attempting to follow, BHC is a good option to consider for further research.

Horizon Therapeutics (HZNP): The 9.23% HZNP position was purchased in Q2 2017 at prices between $9.65 and $15.75 and increased by ~40% in Q4 2017 at prices between $13 and $15. There was a ~23% stake increase in Q3 2019 at prices between $23 and $28. The stock is now at $49.56.

Takeda Pharmaceutical (TAK): The fairly large 7.67% TAK stake came about as a result of Takeda’s Shire plc acquisition in a cash-and-stock deal ($90.99 cash and 5.034 shares of TAK for each share of SHPG held). Paulson had a ~10% portfolio stake in Shire plc for which he received these shares after that transaction closed in January. Takeda currently trades at $18.93.

Mylan NV (MYL): MYL stake is now at 6.83% of the portfolio. The original stake was purchased in Q1 2010 at prices between $17 and $23. Last significant buying was in Q2 2015: ~50% increase at prices between $58 and $76. 2017 and 2018 had seen a ~50% selling at prices between $30.50 and $47. The stock currently trades at $15.64. There was a ~9% stake increase in Q3 2019.

BrightSphere Investment Group (BSIG): The 4.88% BSIG stake was built in Q4 2018 at prices between $10 and $13.30. Q1 2019 saw a huge ~285% stake increase at prices between $11 and $14.25. The stock currently trades below those ranges at $8.34.

Note: Paulson’s ownership stake in BSIG is ~25%.

DISH Network (DISH): DISH is a 3.79% portfolio position established in Q1 2017 at prices between $58 and $64. Q2 and Q3 2017 saw a combined ~36% stake increase at prices between $52 and $66. The stock is currently well below the low end of those ranges at $29.56. There was an ~11% trimming in Q4 2017 while next quarter there was a ~19% stake increase.

ViacomCBS (VIAC): Paulson had a small ~1% of the portfolio stake in Viacom as of Q3 2019. Following the ViacomCBS merger transaction, they increased the stake substantially at prices between $35.50 and $42.75. The stock currently trades well below that range at $19.59. The stake is now at 3.21% of the portfolio. For investors attempting to follow, VIAC is a good option to consider for further research.

Pacira BioSciences (PCRX): The 2.20% PCRX stake was built in Q2 & Q3 2019 at prices between $35.50 and $48 and it is now at $45.10.

International Tower Hill Mines (THM), SSR Mining Inc. (NASDAQ:SSRM), and Trilogy Metals (TMQ): These small (less than ~1% of the portfolio each) stakes were kept steady this quarter.

Note 1: Paulson has a ~32% ownership stake in International Tower Hill Mines.

Note 2: Although the position size relative to the size of the portfolio is very small, it is significant that Paulson owns ~10.5% of Synthesis Energy Systems (SES).

The spreadsheet below highlights changes to Paulson’s US stock holdings in Q1 2020:

Disclosure: I am/we are long ABBV, FMCC, FNMA, MYL, VIAC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We are long Fannie/Freddie Pfds.





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Rogers Sugar Inc. (RSGUF) CEO John Holliday on Q2 2020 Results – Earnings Call Transcript


Rogers Sugar Inc. (OTC:RSGUF) Q2 2020 Earnings Conference Call May 5, 2020 5:30 PM ET

Company Participants

John Holliday – President & CEO

Manon Lacroix – VP, Finance, CFO & Secretary

Conference Call Participants

Michael Van Aelst – TD Securities

Stephen MacLeod – BMO Capital Markets

Endri Leno – National Bank Financial

Frederic Tremblay – Desjardins Securities

Operator

Good afternoon, ladies and gentlemen, and welcome to the Rogers Sugar Second Quarter 2020 Results Conference Call. [Operator Instructions] Please note that this call is being recorded today, May 5, 2020 at 5:30 p.m. Eastern Time. I would now like to turn the meeting over to John Holliday, Chief Executive Officer. Please go ahead, Mr. Holliday.

John Holliday

Thank you, Operator, and good afternoon, ladies and gentlemen. Joining me for today’s conference call is our CFO, Manon Lacroix. During today’s call, I will provide broader context to the business and some insight on trends or changes in the industry and provide an update on the evolution of our business strategy.

Please be reminded that today’s call may include forward-looking statements regarding our future operations and expectations. Such statements involve known and unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied today. Please also note that we may refer to some non-GAAP measures in our call. Please refer to the forward-looking disclaimers and non-GAAP measure definitions included in our public filings with the Securities Commission for more information on these items.

The past quarter has brought our business [technical difficulty], some plans such as the completion of our Maple project 2020 work and much unexpected disruption. Our first challenge came as a result of a 3-week rail blockade which disrupted Ontario and Western Canadian supply plans that we had developed to bridge the Taber 60,000-metric tonne crop shortfall. This event was closely followed by the coronavirus pandemic that has disrupted life as we know it. As an essential service business, we responded to the coronavirus by reorganizing our manufacturing and administrative functions to ensure the uninterrupted supply of products while also protecting the health and safety of our employees.

On a more positive note, at the end of the quarter, the U.S. government officially confirmed a sugar supply shortage and provided Canada with an allocation of an additional 5,000 metric tonnes of beet sugar and a global duty-free quota for an additional 176,000 metric tonnes to be filled on a first come first served basis. This event triggered the need to develop yet another new sales and operating plan that will allow us to supply the additional sales against this new market opportunity.

I am proud of how well the team has risen to meet these challenges and work together to build a safe and adaptable and sustainable business model that delivered uninterrupted service to our customers. It has also been very satisfying to share with our employees the positive feedback and thanks that we’ve received from multiple customers for our reliable and responsive supply during these unprecedented times.

These changes have impacted our business in a variety of ways that I would like to take a moment to discuss. Overall, sales volumes are generally positive for both Sugar and Maple with lower volumes in some segments being offset by growth in others. Operating costs are generally higher due to temporary increases in expenses such as nonstandard supply chain costs, temporary wage premiums and health and safety consumables. In addition, manufacturing efficiency has lowered due to the commissioning delays and modified staffing plans to comply with our enhanced health and safety protocols driven by our response to COVID-19.

Raw material supplies experienced longer lead times and require more planning. We continue to monitor these situations closely and where possible are keeping more inventory on hand. Capital spending has been delayed somewhat as we experienced some delays in equipment supply and limited access to our facilities for essential services only. These delays do not pose any risk to our operations.

Overall, much of what we are currently facing is unknown. We believe our business and our actions to date will allow us to continue to deliver year-on-year EBITDA improvements, maintain our dividend and have cash available to continue to reduce debt or buy back shares.

Consolidated EBITDA in the second quarter was approximately $16.5 million, in line with the same period last year. We are very pleased with the results we achieved in our Sugar business. The plans we made, which included ramping up production capacity at our Vancouver and Montreal refinery, along with some selected importation of refined sugar were all well executed and allowed us to fill customer orders despite the shortage caused by the Taber crop. Extensive planning that went into our original sales and operating plan has allowed us to respond quickly to the new U.S. Sugar quota and secure 5,000 metric tonnes of additional beet sugar toward allocation.

Our cane refineries are operating well. Vancouver continues to see operational improvements, and Montreal, for their past and recent investments in equipment and higher maintenance expense, is consistently delivering above plan volumes. The strong performance has allowed us to increase our sales outlook from the second quarter to capitalize on the quota and the new high tier sales opportunities in the coming months.

Overall, we continue to expect domestic volume growth in the low single digits, and given the announcement for additional U.S. tariff quotas and the general tight supply conditions in that market, we expect opportunities for near term growth in the United States. With a proven reconfigured supply chain and assets that are running well, we are now projecting our total sales for fiscal 2020 to be approximately 750,000 metric tonnes, a 9,000 metric tonne improvement on fiscal year 2019 shipments. Considering the loss of 60,000 metric tonnes of sugar production at the start of the year, this will be an outstanding achievement.

Turning to our Maple operations for the quarter, the planned move to the new facility in Granby was completed on time. Commissioning the new facility has been delayed by COVID-19 which restricts access of third party contractors. COVID-19 further disrupted our Maple operations in the quarter as new operating procedures were put in place to maintain employee health and safety. These procedures are generally more impactful on work in the Maple operations due to the proximity of people working on the packing lines. Despite these challenges, the plants were still able to increase production by 15% versus the same quarter a year ago.

Work to compete the commissioning will be completed in the third quarter using reassigned internal resources from our refining business. Employee work procedures and line modifications are also being made so we can maintain employee safety and recapture some lost productivity.

The completion of a total reconfiguration of our Quebec manufacturing footprint is a significant and important milestone for our business. As a global industry leader in the maple syrup industry, with a continuous improvement mindset, we will leverage this platform to deliver high quality, low cost products to our customers.

Some mention has been made in the media about the impact of COVID-19 on maple syrup supply. These reports were focused on traditional sugar shack business which has been curtailed. This situation does not have any impact on maple syrup production which although not yet complete, is projected to be above average. We’ll be able to report on this in more detail in the next quarter.

Moving onto some other developments, the new Canada-U. S. trade agreement which was recently ratified is expected to increase our sugar quota by 96 [sic] metric tonnes annually. As quotas are established on a calendar year basis, these additional volumes will be adjusted on a pro rata basis in this calendar year. We expect to have access to this new quota starting in July. However, the reduced Taber crop in Taber this year and the USDA’s allocation of 5,000 metric tonnes of beet sugar against the recently announced refined sugar quota, we anticipate the new pro rata volume will be delivered in the first quarter of fiscal 2021. This carryover and the new 2021 calendar allocation will provide us with approximately 25,000 metric tonnes of quota in fiscal 2021.

In anticipation of the larger quota associated with the new Canada-U.S.-Mexico trade agreement and a need to rebuild our supply pipeline for beet sugar, we will plant a record 30,000-acre crop which we expect to deliver an estimated 132,000 metric tonnes of sugar.

Before handing the call over to Manon to review financial results, I want to reemphasize that we remain positive on our view of the Sugar segment and expect to generate higher EBITDA than last year. With respect to the Maple business, the footprint optimization is now complete and we are seeing good operational improvements at each site. Moving forward, as commissioning is completed, we expect to continue to benefit from improving efficiencies and service levels. As we enter into the important pricing season, we are now turning our attention to margin improvement where we will be adjusting pricing to recover costs and manage our profitability whilst maintaining customer loyalty and market competitiveness.

Finally, I want to thank again our employees for their ongoing efforts and collaboration. Especially during the current COVID-19 situation where we have proudly demonstrated their commitment to our customers. With that, I turn the call over to Manon.

Manon Lacroix

Thank you, John. This earnings season will be marked by COVID-19 and its impact on people and businesses. Although it has been very challenging times, we are pleased to report that COVID-19 has had minimal financial impact for Rogers Sugar for the quarter.

Now looking at the second quarter results in more detail, I will start by discussing the Sugar segment. As John mentioned, our overall sales volume for the quarter was in line with the second quarter of last year. We estimate that the volume impact associated with COVID-19 was minimal in all segments except for the consumer segment. Consumer volume increased by approximately 4,800 metric tonnes compared to the previous quarter, continuing the quarterly trend of year-over-year improvements we have seen for the past year. The incremental sales in the second quarter were mainly associated with new business gain in fiscal 2019 from a national retail account. In addition, the COVID-19 driven pantry loading movement, which started in mid-March, has provided increased demand and growth in the segment and contributed to the quarter-over-quarter improvement.

Volume also increased in our liquid segment with an increase of approximately 3,300 metric tonnes driven by incremental volumes on new accounts gained later in fiscal 2019 and continued strong demand from existing customers. The impact of increased consumer and liquid volume in the quarter was offset by lower industrial and export volume. The Industrial segment sold approximately 6,100 metric tonnes less than the comparable quarter last year, of which approximately 2,000 tonnes was driven by the rail blockades that occurred in February, and impeded transportation to our Toronto distribution center resulting in lost volume to the competition. Volume also lowered in the quarter due to timing in deliveries.

Finally, as expected, export volumes lowered by approximately 1,800 metric tonnes compared to the same quarter last year, due to planned reductions and shipments to Mexico. The postponed shipments have been rolled over to fiscal 2022, allowing us to meet the needs of our domestic customers.

For the Sugar segment, adjusted gross margin and adjusted gross margin rates for the current quarter were comparable to last year. Maintenance costs were $1.8 million higher than last year as we incurred incremental spending to ensure the reliability of our cane facilities in Montreal and Vancouver as we ramped up production volumes to offset the shortfall in Taber. In addition, gross margin was impacted by $1.6 million in additional costs associated with refined sugar imported and largely sold in the quarter. We chose to import refined sugar in the quarter as a way to reduce supply chain risk. The remaining variance was due to lower byproduct revenue, somewhat offset by a reduction in energy costs, both of which were driven by the smaller crop in Taber

Overall, results were comparable to the same quarter last year as the incremental costs incurred in the current quarter were offset by costs related to facility commissioning in Vancouver incurred during the second quarter of fiscal 2019. As expected, the smaller crop in Taber added $1.1 million in distribution costs for the current quarter. This increase was partly offset by incremental distribution costs incurred in the second quarter of last year of $0.8 million relating to the Vancouver commissioning issues.

Overall, the Sugar segment’s adjusted EBITDA for the quarter was $0.4 million above last year’s comparable quarter. The adoption of IFRS 16 on the Sugar segment resulted in an increase of $0.8 million for the current quarter which was partly offset by the increase in distribution costs.

Now I’ll turn to the Maple products segment. We are pleased to report that our revenue in the quarter were 10.6% or $5.3 million higher than the comparable quarter last year as a result of increased demand from large accounts and pantry loading associated with COVID-19. Adjusted gross margin for the quarter decreased by $0.6 million when compared to the same quarter last year, resulting in a decrease of 2.1% in adjusted gross margin percentage. The impact of increased sales volume was offset by a reduction in adjusted gross margin due to competitive pressures experienced in the second half of fiscal 2019 that carried into the current quarter.

In addition, labor costs increased by $0.6 million during the current quarter due to an increase production volume to meet demand and added production capacity prior to the move to the new Granby location at the end of January. Finally, assets acquired for the footprint optimization project and the lease of the new Granby location resulted in an increase of $0.3 million in depreciation expense. Overall, adjusted gross margin for the second quarter of fiscal 2020 amounted to $4.4 million. Administration and selling expenses were $0.3 million higher than the comparable quarter last year mainly driven by additional employee benefits.

The Maple products segment adjusted EBITDA for the second quarter amounted to $2.7 million, down $0.4 million from the comparable period last year. The adoption of IFRS 16 on the Maple products segment resulted in an increase of $0.2 million for the current quarter. Consolidated adjusted EBITDA at $15.5 million was in line with the second quarter of last year, as improvement in the Sugar segment was offset by lower adjusted EBITDA in the Maple products segment.

During the quarter, the company acquired approximately 1,150,000 common shares under the normal course issuer bid for a total cash consideration of $5.4 million. Prior to quarter end, an automatic share purchase plan was put in place to continue to purchase shares during blackout periods. The NCIB was completed on March 30, 2020 following the purchase of all 1.5 million shares approved by the TSX.

Free cash flow for the trailing 12 months decreased by $9.9 million versus the comparable period last year. Free cash flow decreased as a result of lower adjusted EBITDA as well as $3.1 million in incremental share purchase under the share buyback program, higher payments for capital leases, higher interest paid, and higher capital spending net of operational excellence CapEx. This was partly offset by a reduction in income taxes paid and lower pension plan contribution. We are pleased to confirm that the declaration of a dividend of $0.09 per common share to shareholders of record on June 26, 2020 and payable on or about July 21, 2020. The total payout is estimated at $9.4 million.

I will now turn to the outlook for the remainder of fiscal 2020. It is important to note that our outlook assumes that our plants will continue to operate fully despite the COVID-19 pandemic. Starting with the Sugar segment, our volume expectations for fiscal 2020 have increased to approximately 750,000 metric tonnes, an increase of roughly 9,000 metric tonnes compared to fiscal 2019.

As John mentioned, we should benefit in the second half of the fiscal year from newly announced Canadian and global U.S. special quotas which we intend to maximize. Therefore, despite having reduced deliveries to Mexico earlier this year, we now anticipate that the total export volume should be comparable to fiscal 2019. No additional volume is expected from the Canada-United States-Mexico agreement in the current fiscal year.

As for the domestic market, we expect that an increase in consumer volume driven by COVID-19 may be offset by an anticipated reduction in the food service sector. Meanwhile, we expect minimal impact from the industrial and liquid segments. As a result, our expectations remain unchanged from the previous quarter with an increase in consumer volume of approximately 10,000 metric tonnes and comparable volumes for the industrial and liquid segments.

We will continue to backfill the volume shortfall from the reduced beet crop from production from our cane refineries.

As a result, distribution costs are expected to increase versus fiscal 2019 as we ship bulk sugar to Taber to mostly service our domestic liquid customers.

Our initial estimate assumes additional costs related to COVID-19 of $1 million driven by a $2 per hour temporary premium paid to our employees working at our plant and by an increase in spending on the health and safety supplies. Overall, despite the challenges resulting from the smaller crop in Taber, we continue to expect that the Sugar segment adjusted EBITDA will exceed fiscal 2019 results. The increase in volume, the reduction in energy cost in the first half of the fiscal year, and the margin improvements from the additional consumer and special quota export volume are expected to be beneficial for the current year.

In addition, the financial impact from the Vancouver commissioning issues encountered in fiscal 2019 are behind us. All these elements should more than offset the additional costs expected as a result of the smaller production volume in Taber.

Capital spending for the current year is expected to be between $17 million and $19 million instead of the previously anticipated total of $20 million. The reduction is driven by a slowdown of projects associated with COVID-19.

Now turning to the Maple products segment, we have experienced a more stable competitive environment over the past few months. And as such, we expect that adjusted gross margin rates should remain comparable to year-to-date results. Although we continue to see strong demand associated with COVID-19, we do not project that this trend will continue for the rest of the fiscal year. Labor costs for the second half of fiscal 2020 are expected to improve versus the first half, but should remain above previously anticipated levels due to inefficiencies associated with COVID-19 and ongoing improvements required on new and installed equipment.

Capital spending for the Maple product segment should be approximately $6 million which is mostly related to the footprint optimization project. Less than $1 million is anticipated to be spent in the second half of the current year. We expect that free cash flow will cover the company’s dividend payment as improved adjusted EBITDA and lower capital expenditures net of operational excellence projects are expected to drive an increase in free cash flow when compared to fiscal 2019 despite having purchased more than 6 million in shares.

With that, I would like to turn the call back over to the operator for questions.

Question-and-Answer Session

[Operator Instructions] Your first question comes from Michael Van Aelst from TD Securities. Your line is open.

Q – Michael Van Aelst

Good afternoon. The volume outlook for the second half looks obviously quite good, so I wanted to focus more on the margins. So starting on Sugar, the EBITDA was flat despite having some significant additional costs last year due to inefficiencies. And I know you called out some higher costs in maintenance of $1.8 million and I guess imported refined sugar $1.6 million, so that’s $3.4 million. I think it was somewhere closer to $5 million last year, definitely over $4 million last year. So I’m wondering what else might have happened on the consumer gross margin in the quarter. Was that just mix or is that something else? Consumer was strong and industrial and liquid was down, so you would have thought that margin improvement would have been a bit better.

Manon Lacroix

The piece that you’re missing is the byproduct revenues. They had significant impact in the quarter because of the smaller crop in Taber. Beet pulp in particular was lower than last year. So that’s the other reason why the EBITDA, the gross margin was flat quarter-over-quarter.

Michael Van Aelst

So would that have been at least $1 million?

Manon Lacroix

Yes, definitely.

Michael Van Aelst

Okay. And on the Maple side, again, that margin — so I’m a little confused here because in Q1 you had I think it was a $0.45 per pound margin and you had talked at the time about competition had stabilized in the recent months and you expected margins to be stable. But now it’s I think you had $0.34 a pound in this quarter. So what changed on that front?

Manon Lacroix

There’s two elements to the reduced gross margin Q1 to Q2. The main, one of the main reasons is labor cost. If you are looking at the labor costs for the current quarter were above last year, last quarter, because of the move in Granby, higher production, some inefficiencies because of the COVID and higher overtime. So that’s one part. The second part is we’ve been talking about a stabilized competitive environment, but the negotiations that we’d done last year had resulted in reduced margin rates that we are carrying into this quarter. So quarter-over-quarter it doesn’t have an impact, but the mix of products that we sold to our customer, it was strong in particular in the retail large accounts and overall the margin rates for those accounts are lower. So that brought the margin rate down quarter-over-quarter when you’re comparing Q1 to Q2.

Michael Van Aelst

Okay, and those employee — the higher costs tied to labor that you called out, moving to Granby, inefficiencies, COVID. Are you — are the moving costs to Granby, is that behind you now and the inefficiencies?

Manon Lacroix

We expect that labor costs in the back half will be still higher than expected, but lower than Q2. There is still some inefficiency gains to be had on the production lines, but the actual move and the commotion about that is behind us.

Michael Van Aelst

Okay. All right, then on your, on the extra quota — I missed some numbers there. So you said for, I think you said you’re going to deliver 25,000 metric tonnes more in fiscal 2021 from the Canada-U. S. trade agreement. What was the number, what did you expect to deliver in Q1 fiscal 2021 and in this current year?

John Holliday

In this current year, we’ll deliver our full quota which is the 9,600, And we have the additional access to the quota that was associated with the sugar shortfall in the U.S. which is an additional 5,000 tonnes. And the 2021, fiscal 2021 quantity is correct, 25,000 tonnes. And the timing of that will be dependent on market opportunities where think it is best to complete those sales.

Michael Van Aelst

Okay, so the 25,000 metric tonnes, is that an increase year-over-year or is that your total quota then?

John Holliday

That’s the total quota. So a normal quota would be 9,600. So it includes 9,600 of the historical U.S. Trade Agreement and new 9,600 for the calendar year 2021. And the carry forward of the allocation, the pro rata allocation that we have this year that we won’t use because we do not have the sugar to sell and we’ve used whatever sugar we had to sell against this one-time quota that we just received.

Michael Van Aelst

Okay. Can you give us any idea how much you were able to ship into the U.S. under the global quota allocation and whether that door is closed now?

John Holliday

The door is not closed. It’s different than historical. It’s typically a run to the border and first come first serve, and the USDA determined that they were going to provide tranches. So the first two tranches have been filled. I believe there’s three more tranches to go and the first two tranches were filled at roughly say 25% of what people shipped. So we can’t establish exactly what our quota allocation will be by the end of the process. What isn’t sold under the quota will be sold as high tier into the United States. So the high tier market is attractive because No. 11 sugar is probably in the $0.10 range, $0.10 to $0.11 range, which is traditionally low, and the Canadian dollar is weak, so it makes those opportunities also attractive.

Operator

[Operator Instructions] Your next question comes from Stephen MacLeod from BMO Capital Markets. Your line is open. Stephen MacLeod, your line is open.

Stephen MacLeod

Oh, hi there. Sorry, I was on mute. Apologize for that. Hi, John. Hi, Manon. Thank you. I just wanted to follow-up on the Maple segment. Particularly around the competitive pressures easing. And I think I just want to clarify kind of how that dovetails with Manon, your comment that contracts entered into last year are still carrying lower margins. Can you just talk a bit about what’s happened in the competitive environment over the last few months? And where do your margins shift? Do you expect them to eventually increase?

John Holliday

I’ll tackle some of that. So from the competitive — we characterize it as stabilized. Meaning not gone, not been any worse, not been any better. So we’ve even able to recover, renew business largely at margins that we had before. We are — there’s not much pricing activity that happened in the last quarter. We’re entering into that period of pricing now and as we mentioned in the call, what we intend to do is recover increased costs and we are looking for improving our margins in the business, but we will be doing that in a manner which ensures that we are able to remain competitive in the industry and protect our business at the same time. So the market has been stable, looking to enter into the pricing period, recovering costs, and looking to improve our margins. But do so with the intent of also maintaining our business.

Stephen MacLeod

Okay, that’s helpful. Thank you. Then I just wanted to follow-up on Michael’s question around just the quota. I can’t seem to find that 25,000 reference in the MD&A in fiscal 2021. Could you just clarify, I know you’ve mentioned it a couple of times, but I just want to make sure I’m understanding it correctly, just when those volumes will flow through and what the different programs are?

John Holliday

We have — they’ll flow through in the full fiscal year. We don’t have a prescribed we’ll sell X metric tonnes in every month. We make the decisions on when we think the best timing is in the market to sell that sugar. And that 25,000 metric tonnes comes from the two, the existing quota of 9,600, the new quota of 9,600, and the pro rata share of the new quota that will not be shipped in this fiscal year, but be shipped in the last quarter of this fiscal year. So I guess if there’s any fore signing, it will be we’ll be shipping that 4,000 or 5,000 tonnes before the end of this calendar year.

Stephen MacLeod

I see. And then does any portion of that come from the global refine tier two quota that you referenced of 167,000 metric tonnes?

John Holliday

No, none whatsoever.

Stephen MacLeod

How does that work? You said it’s first come first served. How does that work in terms of bidding on that business?

John Holliday

You basically need to have the product in the United States, cleared customers, that we can ship across the border and we can put it into bonded warehouses, have it ready, and then once the quota is made available, then people apply against it and they allocate on a pro rata basis.

Stephen MacLeod

Okay, that’s great, thank you. Then maybe just finally, you outlined your COVID, the estimated COVID cost impact of $1 million. Is that what would you expect? Do you see that potentially moving higher over time? Or what would be the biggest delta that would make that move either lower or higher?

Manon Lacroix

You could split it half/half. Half is on the premium that we’re paying to our employees that are showing up to work, so it’s a $2 per hour premium that we’re paying. So this number would go up if we were to go past the end of May. And then the other half is on health and safety equipment, our supplies and I think it should be a good estimate.

Operator

And we have another question from Michael Van Aelst from TD Securities. Your line is open.

Michael Van Aelst

Yes, so the Maple pricing activity that you’re negotiating now, what period does that typically kick in at? Is that — does that start in Q3 or does that start next year or when?

John Holliday

It will start in Q3. We do not have long term contracts in the Maple business.

Michael Van Aelst

All right. Then I think in Maple you talked about an employee benefit as well. Or employee benefits had an increase. Is that — that was in your admin and general. Is that a one-time occurrence or is that an increase in wages and benefits, or what is it?

Manon Lacroix

It’s not a one-time, it’s something that you would expect would continue. It’s additional employees effectively.

Michael Van Aelst

Okay, increased employees. Okay. Why do you need increased employees given that you’re becoming more efficient in the plants that you have?

Manon Lacroix

We’ve added personnel in selling in particular and we have also added personnel in accounting, support staff.

Michael Van Aelst

Okay. And have you got efficiencies that you wanted to at Degelis yet?

John Holliday

In Degelis we got to the line efficiencies that we anticipated and we took a little bit of a step back because of COVID because some of the line efficiencies are driven by operating practices that we cannot support, or could not initially support in the COVID environment. So they were lost for probably 6 to 8 weeks. We’ve got plans on how to reconfigure some of the work to ensure that we’re protecting the health and safety of employees and recover or recuperate some of those efficiencies to get back to where we were which is where we plan to be.

Michael Van Aelst

Okay. And in Granby, I think in Q1 you were still working out of that, both plants. In 2Q, did you close the old plant already?

John Holliday

We closed it on the — we switched over to the new plant on the 1st of February, 31st of January.

Michael Van Aelst

Okay. And then you talked about cutting down your backlog by I think it was 50% last quarter. Are you caught up on the backlog yet?

John Holliday

We fully caught up on the backlog that we had. Where I would say we have transitioned to, we had a good quarter in volume, we had a particularly good quarter in the month of March, and we had a very strong quarter or strong start to the month which Manon alluded to. So we don’t have a backlog. We had lead times that are longer because the order demand is significantly different than normal.

Michael Van Aelst

So we’ve seen, because you mentioned that you had strong demand in I guess the back half of March, but then I thought you also said in your guidance that you didn’t expect that to continue. But so far it is?

John Holliday

So far. We had a good month of April, absolutely. But we have no way, and this very uncharted waters for us and for everybody with response to what will happen to the long-term demand. So we’re not trying to forecast continuation because we don’t have any basis from which to do that.

Michael Van Aelst

Okay. And the strong growth, is it coming from within Quebec or are you starting to see improvements in the rest of Canada and U.S. after you boosted your marketing spend?

John Holliday

It’s in the U.S., it’s in Europe, both. Those two markets stand out.

Michael Van Aelst

Okay, and rest of Canada, any progress there yet?

John Holliday

Yep, in there as well. Relative to what we’re seeing short term which is hard to kind of separate from what’s COVID and what’s normal course of business.

Michael Van Aelst

Okay. And as you move into export markets like U.S. and Europe, are those typically higher margin markets for you? Or are you going to be pricing aggressive to get it?

John Holliday

It’s more account specific. So I don’t think it’s — I wouldn’t want to characterize it totally as geographic.

Operator

Your next question comes from Endri Leno from National Bank Financial. Your line is open.

Endri Leno

Thanks for taking my questions. The first one, just wondered if you would clarify a little bit on the Maple side of business. Because you mentioned that you want to, when you go into the new pricing environment, get new contracts to recover some of the lost margin or improve margin amongst other things. But at the same time, protect your market share. I was wondering if you can explain like how you intend to do that.

John Holliday

How do we expect —

Endri Leno

How do you expect margin improvement while protecting market share?

John Holliday

Because we think that the marketplace will accept that and because there’s a recognition that the market has been under significant pressure and cost recovery will be a requirement and we believe that modest changes to improve our margin are reasonable and acceptable.

Endri Leno

Okay, great. Thank you. Another, I think it was Manon that mentioned that you expect some of the food service sector declines, the food service sector to offset gains in the consumer on the Sugar side of business. How has that dynamic played so far into Q3? And yeah, how has that played so far in Q3?

Manon Lacroix

Well I think the demand is somewhat of a similar answer to what John discussed on the Maple side. I mean consumer volume is still strong on the Sugar side in April, it’s hard to tell really what we think is going to happen. But we did see some reduction on the food service sector, although it’s not a big portion of our business.

Endri Leno

Okay. Are you able to at least kind of ballpark quantify like what percentage of the volumes would be consumer and what percent would be food service?

Manon Lacroix

Oh, the consumer sector is much higher. It’s not even comparable. But if you’re looking at our volume, we’re still calling the full year 10,000 up on the consumer side. And year-to-date we’re up roughly 12,000 tonnes. So look, I can mean ballpark, it’s small numbers.

Operator

Your next question comes from Frederic Tremblay with Desjardins. Your line is open.

Frederic Tremblay

Thank you. In the Sugar segment, you mentioned $1.8 million in incremental maintenance costs and $1.6 million from imported sugar. Was just wondering if those are one-time costs or if we should expect that to be reputed in future quarters, repeated in future quarters, pardon me. And wondering how that would tie into your expectations for adjusted gross margin in the future quarters for Sugar.

Manon Lacroix

Okay, well first of all, on the maintenance side, this quarter we were above on the maintenance. It was mostly driven by a ramp up of our operations. In Montreal for example we do a shutdown at Christmas and we took advantage of it to do more maintenance. And also, in Vancouver because of the increase in production, it’s effectively 50% more than we did in the past as the maintenance costs have gone up. But again, it was more on preventive, making sure that the plants were reliable and maintain productivity. In the back half, I would expect that the maintenance costs would stabilize and be more comparable to the previous year. On the refined sugar purchases, we did buy more than we bought and sold in the quarter, but there’s more to come. So I would expect maybe like double that I guess likely that will come in the backend, back half of the year. And then on your gross margin, obviously the TRQ got added, that will be beneficial on our gross margin. And additional volume as well in the back half, that will be positive. Versus last year, the main impact was in the second quarter regarding the Vancouver commissioning issue. There was some cost in Q3 but not as much. So that should be also beneficial on the gross margin.

Frederic Tremblay

Thank you. And then on the Maple business, are you able to quantify what percentage or proportion of your Maple business is subject to the pricing discussions that you mentioned in the coming weeks? Is it the majority of the business that’s impacted by that?

John Holliday

No, I don’t have a comment on that.

Operator

We have another question from Michael Van Aelst from TD Securities. Your line is open.

Michael Van Aelst

All right, third time in, hopefully the last time. I think you — did I hear you say that year-to-date your consumer volumes were up 12,000? Because I see it up 8,400 —

Manon Lacroix

Yes, sorry. Yes, 8,400, yes.

Michael Van Aelst

Okay, so you’re almost up 10,000 year-to-date and we’re still going through COVID, people are still at home cooking more, baking more. Is there some reason why you’re being so conservative on that consumer volume?

Manon Lacroix

I think it’s just very hard to predict how long it’s going to continue. And we went the conservative route to predict the volume. It could be soft, it could be stronger than that, depending on how long it lasts.

Michael Van Aelst

Is there any category that you think you might be, might not be as conservative then in your guidance?

Manon Lacroix

No, they’re pretty — there’s movement, but for example on the industrial, it’s really minimal. From one year to the next, even if you move like 5,000 tonnes up and down, it’s really tiny, it’s like less than 1%. So it’s kind of similar situation. I think that probably consumer is the part where is maybe the most conservative and then on the export side, we’ll try to maximize as much as we can on the exports with the TRQ or the high tier.

Operator

We have no further questions. I’ll turn the call back over to the presenters for closing remarks.

John Holliday

Okay. Well, everybody, thank you very much for your time and your questions. We will talk to you at the end of the next quarter. Have a good day and be safe.

Manon Lacroix

Thanks, everyone.

Operator

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.





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Aaron’s, Inc. (AAN) CEO John Robinson on Q1 2020 Results – Earnings Call Transcript


Aaron’s, Inc. (NYSE:AAN) Q1 2020 Results Conference Call May 7, 2020 10:00 AM ET

Company Participants

Michael Dickerson – Vice President of Corporate Communications & Investor

John Robinson – President and Chief Executive Officer

Ryan Woodley – Chief Executive Officer of Progressive Leasing

Douglas Lindsay – President

Steve Michaels – Chief Financial Officer and President of Strategic operations

Conference Call Participants

John Baugh – Stifel

Bobby Griffin – Raymond James

Brad Thomas – KeyBanc Capital Markets

Anthony Chukumba – Loop Capital Markets

Bill Chappell – SunTrust

Kyle Joseph – Jefferies

Vincent Caintic – Stephens

Operator

Good morning. My name is Elisa, and I will be your conference coordinator. At this time, I would like to welcome everyone to the Aaron’s, Inc. First Quarter 2020 Earnings Conference Call. [Operator Instructions]

I will now turn the call over to Mr. Michael Dickerson, Vice President of Corporate Communications and Investor Relations for Aaron’s, Inc. You may begin your conference.

Michael Dickerson

Thank you, and good morning, everyone. Welcome to the Aaron’s, Inc. First Quarter 2020 Earnings Conference Call. Joining me this morning are John Robinson, Aaron’s, Inc., President and Chief Executive Officer; Ryan Woodley, Chief Executive Officer of Progressive Leasing; Douglas Lindsay, President of the Aaron’s business; and Steve Michaels, Aaron’s, Inc., Chief Financial Officer and President of Strategic Operations.

Many of you have already seen a copy of our earnings release issued this morning. For those of you who have not, it is available on the Investor Relations section of our website at aarons.com.

During this call, certain statements we make will be forward-looking. I want to call your attention to our safe harbor provision for forward-looking statements that can be found at the end of our earnings release. The safe harbor provision identifies risks that may cause actual results to differ materially from the content of our forward-looking statements.

Also, please see our Form 10-K for the year ended December 31, 2019, for a description of the risks related to our business that may cause actual results to differ materially from our forward statements. Listeners are cautioned not to place undue emphasis on forward-looking statements, and we undertake no obligation to update any such statements.

On today’s call, we will be referring to certain non-GAAP financial measures, including EBITDA and adjusted EBITDA, non-GAAP net earnings, non-GAAP EPS, which have been adjusted for certain items, which may affect the comparability of our performance with other companies. These non-GAAP measures are detailed in the reconciliation tables included with our earnings release.

The Company believes that these non-GAAP financial measures provide meaningful insight into the Company’s operational performance and cash flows and provides these measures to investors to help facilitate comparisons of operating results with prior periods and to assist them in understanding the Company’s ongoing operational performance.

With that, I will now turn the call over to John Robbins.

John Robinson

Thanks, Mike, and thank you all for joining us today. The world is currently confronting the COVID-19 pandemic, which is creating serious public health issues and inflicting economic damage beyond what most of us have ever experienced. Having been in business for over 65 years, operating in times of uncertainty is not new to Aaron’s.

The Company has navigated the aftermath of many natural disasters and numerous economic cycles. Through these difficult times, Aaron’s has persevered, innovated and thrived. With the safety of our associates and customers as the top priority, our team is laser-focused on successfully managing the business through this crisis and positioning it to succeed after the pandemic passes.

Aaron’s purpose is to provide access to life-enhancing products for our customers with compassion and respect. Never has this purpose been more important than during this crisis, and never have our associates who execute this purpose been more heroic. Whether it is a refrigerator or a laptop, Aaron’s is enabling customers to get the products they must have in a critical time of need. I am humbled by the dedication and compassion our teams have demonstrated to each other, our customers and the communities we serve.

We have made considerable efforts to get back to our communities during this crisis. Of particular note is the so-happy-to-help PPE project that our Woodhaven Furniture team launched in mid-March. The Woodhaven team, led by Tommy Harper, quickly transitioned from furniture manufacturing to the production of personal protective equipment. Through the month of April, we have manufactured and donated nearly 65,000 masks, 20,000 medical gowns and 500 mattresses to medical and elderly care facilities, police and fire departments, and homeless shelters in Georgia, Texas, Florida, Nevada, Massachusetts, New York and the Navajo Nation.

In addition, through our partnership with the Boys & Girls Club of America, we became aware of the need for laptop computers in their member communities. In response to this need, we have donated 200 laptops to clubs in Atlanta and Salt Lake City to enable students to complete their studies from home. These are truly trying times, but I am proud that our associates have continued Aaron’s long tradition of giving back to our communities, particularly in this time of need.

Turning to our performance year-to-date through April. We think of these first 4 months of the year in 3 distinct periods. The period year-to-date through March 15 was marked by revenues, originations, cash flows, portfolio performance and earnings ahead of our expectations. At the onset of the COVID period in mid-March, the Company experienced the closure of retail partner stores and made the decision to voluntarily close Aaron’s business corporate-owned showrooms as part of our efforts to protect the safety and well-being of our associates and customers. During this period, from mid-March until mid-April, both businesses experienced significant reductions in lease originations.

At the same time, we made major changes to our business models and cost structures, preparing for a crisis of unknown depth and duration. This was a period of maximum uncertainty, particularly for our customers. As a result, we modified many of our portfolio servicing efforts and proactively reached out to customers to offer COVID-related payment relief programs, including payment deferrals of up to 90 days. The result was a reduction in customer payments during the period.

Nevertheless, when combined with the tight management of expenses and the reduction in working capital, our liquidity position continued to strengthen during this period. Beginning in mid-April, customers began to receive Care’s Act Relief and enhanced unemployment benefits. In addition, later in the month, some Progressive retail partners and our Aaron’s business corporate-owned showrooms began to reopen. As a result, in the second half of April, we experienced markedly improved performance with a rebound in customer payments and originations.

Overall, year-to-date, the business has generated strong operating cash flows, driven by solid customer payment activity, operating expense management, a significant reduction in CapEx and favorable working capital reductions. The net result of these dynamics is that our balance sheet has delevered since December 31, and we ended April with total available liquidity of approximately $620 million. So while it’s been a tumultuous period for us since the onset of the pandemic, our business has been impressively resilient thus far.

While I’m pleased that our business performed so well in the first quarter, there remains a tremendous level of uncertainty as we navigate this pandemic. Given the weakness in new originations over the last eight weeks, our lease portfolios are smaller than expected as of the end of April. While we’ve seen improving trends in the last few weeks, we expect that revenues will be below our original expectations until we experience a sustained recovery in origination activity. Therefore, we will continue to take a conservative approach to managing expenses, working capital, CapEx and capital allocation.

Before turning the call over to Ryan, I want to again thank our incredible associates across all of our businesses for their dedication and determination over the past eight weeks. I couldn’t be prouder of how you’ve reacted to this crisis. While this pandemic has created a new set of challenges for us, I remain optimistic about our future and excited about the opportunities in front of us.

Now I’ll turn the call over to Ryan to discuss Progressive’s first-quarter performance and recent trends.

Ryan Woodley

Thanks, John. I’d like to begin by acknowledging the remarkable execution of Progressive team during these challenging times. Over a period of just a few days in mid-March, we transitioned our entire workforce to work from home without any system or operational downtime. The team’s resilience and efficiency in overcoming unprecedented logistical challenges, including managing through one of the worst earthquakes in Utah in the last 100 years while transitioning to work from home, enabled us to maintain high levels of uninterrupted performance for our customers and retail partners.

I’d also like to acknowledge our retail partners for their continued collaboration as we have worked together to develop innovative solutions, including e-commerce and curbside alternatives to assist our customers during this difficult economic climate.

Today, I’d like to provide detail on our performance for the quarter overall, as well as to share insight into COVID-related trends that we’ve observed in the last half of March, as well as into the month of April. Through March 15 and prior to the full impact of COVID-19, Progressive posted better-than-expected financial results as reflected in the fact that our revenue, gross margin, customer payments and EBITDA, all performed ahead of our original expectations for 2020. We executed well at our recent national launches, and overall invoice volume was trending in line with the plan.

Net revenues in the first quarter overall reached a new record of $658.5 million, an increase of 25.8% compared to the first quarter of 2019. The revenue performance was driven by continuing strong invoice growth, including an increase of 13.4% in the first quarter. Of note, invoice performance had been trending at a year-to-date increase of 20.7% through March 15. When the closure of thousands of retail doors, particularly in the electronics, jewelry and mattress categories resulted in an abrupt reduction in invoice volume through the remainder of March and into April.

For the period from March 15 to April 15, invoice volume was down approximately 26% from the same period a year ago. From the period April 15 until April 30, invoice volume improved significantly to being down approximately 2% compared to the same period last year. This lower-than-planned invoice volume since mid-March is the primary driver of our portfolio balance at the end of April that was approximately 15% below our original expectations, though still about 6% higher than the end of April 2019.

Notably, we experienced a significant year-over-year increase in application volume in the last half of April, driven by government stimulus and supported in large part by applications originating in our own platforms, including progleasing.com and our Progressive native mobile apps. However, the strong application growth is being offset by lower conversion rates as consumers are unable to transact where retail partner locations have been closed.

Active doors grew 10.2% for the first quarter, driven by prior rollouts of new retail partner locations, and invoice per active door grew 2.9%. As expected, gross margins declined in the period to 29.6% compared to 31.2% in the first quarter of 2019, driven primarily by the trends we discussed on our last call, specifically higher 90-day buyouts due to strong growth resulting from recent national retail partner launches.

SG&A expenses were 10.4% of revenues in the quarter compared to 11.8% in the prior year period, an improvement of 140 basis points. In mid-March, as COVID-19 began to impact the operations of our business and those of our retail partners, we took decisive action to reduce our cost structure in anticipation of declining invoice volume.

As we have mentioned previously, Progressive benefits from a relatively high variable cost structure, which gives us the flexibility to quickly adapt to changes in overall invoice volume. Cost-cutting measures we took were primarily directed to these volume-driven cost centers, while preserving our ability to continue to execute across all functions of the business as well as to invest in important growth initiatives.

Additionally, we curtailed discretionary spending and are continually evaluating the need to maintain these cost controls needs ahead.

Turning to portfolio performance measures. Write offs were 8.5% of revenues in the first quarter of 2020, up from the 7.0% reported in the year ago period. Before the impact of COVID-related incremental reserves, write-offs were 6.6% in the first quarter, an improvement of 40 basis points from the prior year period.

At the onset of the pandemic, given the uncertainty our customers were facing, we took proactive measures to provide payment relief, including deferrals for up to 90 days to customers affected by COVID-19. Though the portfolio performance has remained strong for the year thus far, we believe that we have likely not yet seen the full impact of the economic challenges our customers are facing.

While it is clear that customer payment activity has been assisted in part by the provisions of the Cares Act and enhanced unemployment benefits, it is not possible to completely disaggregate the stimulus-driven effect on payment activity from underlying consumer health.

It is also not possible to predict whether and to what extent the federal government will issue further stimulus and how that stimulus might impact customer behavior. For that reason, in addition to booking our typical reserves that reflect current levels of delinquency, we increased our accounts receivable and leased asset reserves by $16.1 million in the first quarter to reflect our best estimates of potential future losses driven by COVID-19.

In late March, we also tightened our decisioning parameters in an effort to maintain strong performance and insulate the go-forward portfolio against a tougher economic outlook. EBITDA was $70.2 million in the first quarter, an increase of 7.6% compared to the first quarter of 2019. These results include the $16.1 million of COVID-related additions to our write-off and bad debt reserves.

Before the impact of these incremental reserves, EBITDA margin increased approximately 50 basis points in the quarter due to the year-over-year reduction in SG&A and write offs, partially offset by the impact of higher 90-day buyouts in the period.

We are managing the business today in a way we believe will maintain strong portfolio performance and that appropriately sizes our SG&A to a lower level of expected revenues. We believe this will put us in a best position to resume profitable growth as lease originations recover.

In closing, I’d like to reiterate my appreciation for the outstanding work accomplished by teams across Progressive and effectively and efficiently managing through this crisis. Inspired by a commitment to our mission, they somehow packed what seems like a year’s worth of work into 8 short weeks for the benefit of our customers and partners. I couldn’t be prouder.

I’ll now turn the call over to Douglas to discuss the Aaron’s business first quarter results and recent trends.

Douglas Lindsay

Thanks, Ryan. I, too, am extremely proud of the exceptional dedication and contributions of our Aaron’s store and store support center team members during this crisis. I want to thank Ryan Malone, our Head of stores; Rob O’Connell, our Head of Human Resources; our divisional vice presidents and all of our multi-unit and in-store team members for their support of our customers and communities during this challenging time.

On March 20th, we closed all of our corporate-owned showrooms and converted to a curbside and e-commerce-only model. We made the decision to close showrooms with the safety of our team members and customers as our top priority, while doing our best to provide essential products to our customers during this crisis. The feedback from our customers has been tremendous. And I’m proud of our team’s resourcefulness, positive attitude and desire to take care of our customers whose lives, in many cases, have been turned upside down. There is one point I’d like to emphasize.

Given that we are classified as an essential business in most jurisdictions, we could have continued to operate with open showrooms. However, at the onset of this pandemic, we made the decision to close showrooms to protect our team members and customers, while we determined what new safety protocols we needed to implement to operate in a safe manner. In addition to closing showrooms, we made other significant changes to our store operating practices at the onset of this pandemic, including reducing weekly operating hours by more than 50%.

Furloughing 100% of our sales staff, processing new orders and payments at the curb side of our stores, suspending all in-home activities with deliveries and returns to the door only, and implementing COVID-19 payment relief programs for our customers affected by the pandemic. Needless to say, making these changes in such a short period of time is extremely disruptive to our operations. And I want to reiterate how proud I am of our team members who quickly adapted to these changes, enabling us to continue to serve our customers safely during the crisis.

Moving on to the financial results. For the first quarter ended March 31, 2020, revenues were $432.8 million, a decline of 9.8% from the first quarter of 2019, primarily due to a lower store count, a smaller lease portfolio to begin the quarter and weaker customer payments in the second half of March due to the onset of the pandemic. Recurring revenue written into the portfolio declined 1.9% in the quarter. Excluding consumer electronics, recurring revenue written into the portfolio increased 2.7% in the first quarter, with growth occurring in our largest categories of furniture and appliances.

Notably, TVs, the largest component of our electronics category, represented 10.8% of revenue written in the quarter, down from 14.3% in the same quarter last year. This decline is a continuation of a trend we have seen in the last several years. Adjusted EBITDA was 35 million, a decrease of $16.4 million or 31.9% compared to the year ago quarter, resulting from lower revenues and incremental COVID-19-related allowances, partially offset by strong expense management.

Included in adjusted EBITDA for the quarter was approximately $5.7 million of excess bad debt and inventory reserves, resulting from an assessment the future economic environment may be negatively impacted by the COVID-19 pandemic. Write-offs were 6.2% of revenues in the first quarter, driven by an increasing mix of e-commerce and additional COVID-19-related allowances. Including the incremental allowances, write-offs were 5.5% of revenues, down from 7.3% recorded in the fourth quarter of 2019, and as expected, higher than the 4.8% reported in the same period last year.

During the quarter, the Aaron’s business took a charge of $16.4 million to writedown the value of stores permanently closed or expected to be closed this year. This represents a total of 103 locations. While about two thirds of these closures are underperforming stores, the remainder are consolidations or relocations of profitable stores. All of these closures are expected to be accretive to earnings.

These closures are part of our strategy to operate fewer higher-volume stores, along with a robust digital platform, which we expect will improve the customer experience, grow earnings and reduce the capital intensity of the business. I want to provide a little bit more detail on the Aaron’s business results year-to-date through April. From January 1 through March 15, revenues, customer payments and adjusted EBITDA were all performing ahead of our original 2020 expectations. However, in mid-March, as we closed our showrooms and shelter-in-place orders became effective, we saw a recurring revenue written decline to nearly 35% below the prior year, with customer payment trends worsening as well.

This trend lasted until mid-April. Effective April 23, we began a phased reopening of our showrooms across the country, informed by guidance from government authorities and after monitoring trends of COVID-19 cases in counties in which we operate. As part of our reopening, we implemented enhanced operating protocols to ensure the continued safety of our team members and customers, including new standardization procedures, required use of personal protective equipment, modified store layouts and limiting the number of customers in our showrooms.

Additionally, we’ve invited furlough team members of our reopened showrooms back to work.

As of today, 85% of company-owned showrooms are open and operating at regular hours. In the last few weeks, lease originations and customer payments have improved as a result of government stimulus programs and the phased reopening of our showrooms. While overall lease originations are improving, albeit still below our original expectations, stores with recently reopened showrooms are beginning to perform near original planned levels. Over the same period, our customer payments across all stores have performed better than our original expectations.

In addition to changes in our operating model, I want to highlight what a positive impact of technology investments over the past few years have made on our business during this crisis. In late March, we accelerated the planned 2020 rollout of our centralized decisioning platform. We believe this platform allows us to improve the customer and team member experience, better control risk and reduce labor in our stores. Because we have the technology infrastructure already in place and two years of decisioning performance data under our belt, we are able to quickly and confidently convert our U.S. corporate stores in early April.

Additionally, our industry-leading e-commerce platform, aarons.com, continues to be a bright spot for the business. E-commerce recurring revenue written was up 23.4% in the first quarter compared to the first quarter of 2019 and up over 50% in April, despite tightening decisioning in the last week of March, strong performance in April as a result of higher traffic and conversion rates, which drove a surge in e-commerce revenue written in the back half of April.

I’m proud of our operations, technology and data analytics team for continuing to advance our digital capabilities and putting us in a position to serve so many customers through these platforms.

I’m extremely thankful to all the Aaron’s business team members for their extraordinary efforts to serve our customers, our company and our communities during this challenging time. We have an exceptional team in place who’ve executed at a high level and shown great agility during this crisis.

Looking forward, we have a compelling value proposition, an industry best technology platform in aarons.com and a risk decisioning engine that we expect to drive productivity, predictability and risk mitigation. I’m very optimistic about our prospects for the future and our long-term ability to generate sustained growth, strong cash flows and continued innovation.

I’ll now turn it over to Steve to discuss our first quarter financial results.

Steve Michaels

Thanks, Douglas. Let me begin with a few items before moving on to our first quarter financials. First is our goodwill charge.

During the quarter, we conclude that the significant decline in the Company’s stock price and market capitalization during March 2020 triggered the need for an interim goodwill impairment test for the Aaron’s business segment. The Company engaged the assistance of a third-party valuation firm to perform the interim goodwill impairment test. This included an assessment of the Aaron’s business reporting unit’s fair value relative to its carrying value. Fair value was derived using a combination of income and market approaches.

As of March 31st, the Company determined that Aaron’s business goodwill was fully impaired and recorded a goodwill impairment charge of $446.9 million.

Next, in the preliminary proxy filed in early April and again in the final proxy filed this week, among other things, the Company requested shareholders vote to give our Board and management team the discretion to implement a change to a holding company structure. The requirement for a shareholder vote is necessary in Georgia, where we are incorporated, but would not otherwise be required where we incorporate in Delaware as many companies are.

We believe this holding company structure could facilitate future corporate actions and provide greater operational and financing flexibility for Progressive Leasing and the Aaron’s business.

On a consolidated basis, revenues for the first quarter of 2020 were $1.1 billion, an increase of 8.8% over the same period a year ago. Adjusted EBITDA for the Company was $98.5 million for the first quarter of this year compared to $115.2 million for the same period last year, a decrease of $16.8 million or 14.6%. Adjusted EBITDA was 8.9% of revenue in the first quarter of 2020 compared to 11.4% in the same period a year ago.

Adjusted EBITDA includes $28.8 million of incremental bad debt, inventory and CECL reserves resulting from an assessment that the current economic environment and expectations of various projected economic metrics, such as unemployment rates and GDP, will be negatively impacted by the COVID-19 pandemic. Our customer payment activity has been strong through April 30. However, what is unknown is the depth and duration of the current economic slowdown caused by the COVID-19 pandemic and the degree to which government stimulus will continue to support our customers when the current Cares Act and enhanced unemployment benefits lapse.

Again, while the portfolios have performed well and are in good shape today, we believe these reserves represent our best estimate of the potential deterioration we may experience in future periods. Diluted EPS on a non-GAAP basis for the quarter decreased 21% to $0.85 versus $1.08 in the prior year quarter, primarily due to the approximately $0.32 per share of COVID-19-related incremental reserves recorded in the first quarter. Operating expenses increased approximately $25.8 million due to the $14.1 million expense from the termination of a sales and marketing agreement and $14.4 million of COVID-related incremental increases in lease merchandise allowances.

Before the impact of these items, operating expenses were down $2.8 million. This decrease is primarily due to reductions in personnel and occupancy costs in the Aaron’s business, partially offset by increased personnel costs in the Progressive business to support its strong revenue growth over the last year. Cash generated from operating activities was $227.8 million for the first quarter of 2020, and including the funds from a $300 million revolver draw, we ended the quarter with $551 million in cash compared to $57.8 million at the end of 2019.

Cash flow generation was strong during the quarter and has continued through April. The source of cash flows has been the strength of ongoing customer payments as well as lower-than-planned lease originations and resulting working capital reductions. In April, the Company paid $60 million in scheduled debt amortization, $175 million to satisfy its settlement with the FTC and $300 million to pay down its revolving credit facility in full. As of April 30, the Company had a cash balance of $136 million and gross debt of $287 million.

As a reminder, during January 2020, we took advantage of market conditions and amended our existing credit facilities, extending the maturities to January 2025 and increasing the capacity of our revolver by $100 million to $500 million. I’m proud of our finance team for taking these proactive measures, and we ended April with over $620 million in available liquidity, an increase of approximately $175 million since December 2019, even after satisfying $235 million of obligations during the month of April. During the quarter, we did not repurchase any shares of the Company’s common stock, however, we have maintained our quarterly cash dividend. As a reminder, on March 23, the Company withdrew its full year 2020 financial outlook previously issued on February 20th due to the uncertainties resulting from COVID-19.

With that, I will now turn the call over to the operator, who will assist with the question-and-answer period.

Question-and-Answer Session

Operator

We will now begin a question-and-answer session.[Operator instructions] The first question today comes from John Baugh of Stifel. Please go ahead.

John Baugh

Thank you. Good morning and appreciate all the color. A few quickies here. One, could you just tell us what the $14.1 million marketing contract you terminated was about?

Douglas Lindsay

Yes, John, it’s Douglas. As you probably remember last year, we went through a process of looking at our demand side of the business, which was really on how do we drive the increases in marketing in the third and fourth-quarter last year. As part of that, we — I think you explained last year, we drove a lot of volume, but we had some collection challenges in the fourth quarter. We got back — that back under control in the first quarter, and we’re doing really well, and then COVID-19 hit us.

And at March 31, it became clear to us that with our showrooms closing and our sales people furloughed that we weren’t going to get a future benefit from that engagement. So we took the write-off in the quarter.

John Baugh

Okay. And then I’m curious on either side of the business, whether or not you relinquished at all the tightened underwriting decisions you made in the onset of the pandemic?

John Robinson

This is — John, this is John. Good question. No, we — across all our businesses, we tightened in the latter part of March and maintained that. We continued to maintain that approach.

Now despite the fact we did see improving customer payment performance, particularly in the back half of April, but we’ve maintained that more conservative approach.

John Baugh

Got it. And then John, are you seeing a higher quality of applicant in either side of the business for maybe changes in tightened credit above you yet? Or no, that’s not the case in light of the underwriting decisioning again?

John Robinson

Yes. I mean, we — and Ryan, you can feel free to jump in after me. But what I would say is we definitely heard — we’ve heard out there that there is tightening going on in higher FICO bands for sure. But we haven’t necessarily seen it across the board, perhaps we’ve seen it in pockets on the progressive business.

In the Aaron’s business, obviously, we don’t have the same visibility. We’ve seen good demand return in the stores that we have reopened in the back half of April. But what I would tell you is we’ve heard that. But given how short — it feels like this has been two years, but it’s been really eight weeks that we’ve been dealing with this pandemic.

And so I wouldn’t feel comfortable saying there’s any sort of trend that’s developed there thus far. But clearly, to the extent tightening happens above us, and there’s less availability of options for customers, that could be a tailwind for us in the future. But we’re not ready to say that there’s any sort of trend there yet, just given how early we are in this process.

John Baugh

And then Ryan, could you tell us your retail partner base? I don’t know. What — obviously, they were 100% open, and they went to some percentage closed, and then they’re in the process of reopening. Any help with where we are, where we went down to, where we are today? And then kind of give us an update again on your verticals there roughly in terms of percentage?

Ryan Woodley

Yes. Happy to do it, John. So as you might imagine, we saw the most impact where stores and showrooms were closed, particularly in our jewelry, electronics and mattress verticals. Some of the work we did there with some of our partners that I alluded to in the prepared remarks like working on e-com and curbside service alternatives helped to offset the impact that we obviously would have otherwise seen. But that was where we saw the most negative impact as where the showrooms were closed.

Obviously, we did have some who remained open throughout the pandemic, either because they were, in almost all cases, they provided essential services. In all cases, it provided essential services and [indiscernible], and we saw continuing activity out of others and less of an impact. So in — I’d say, a few trends we’re seeing take place across the portfolio. As you think about where we’re at in the evolution of the pandemic, obviously, there’s a ton of uncertainty about where we go from here.

But we are seeing, as you know, state and home orders begin to be lifted and retailers responding to that by beginning their reopening process. We’re seeing that — the beginnings of that in jewelry and electronics. And we’re also seeing the early signs of the impact that’s having on customer activity, customers getting out.

It’s really difficult to disaggregate that from the general increase in the demand we have seen as a result of the stimulus. But that’s obviously encouraging. Some demand that hadn’t otherwise existed, and those are happening somewhat simultaneously. So in summary, we’re seeing a return to demand, so positively increasing trends as we move through that March 15th to April 15th period. And then from April 15th to present has been sort of a gradual improvement sequentially as influenced by those factors.

Operator

The next question comes from Bobby Griffin of Raymond James.

Bobby Griffin

The first question I had is around really the core business. And maybe can you provide a little color on the ability to scale back up some of the cost as demand returns? And how are you approaching that as stores are coming back open now, but the volume is not quite back to trends that you might have been used to in the past?

Douglas Lindsay

Bobby, this is Douglas. Thanks for the question. So first of all, we’re trying to control all the expenses we can control. We’ve suspended a lot of the discretionary spend, let’s say, at the corporate level, we suspended merit increases. We’re working with our landlords on rent. We’re taking a hard look at all of our discretionary spend. As you know, on a temporary basis, we took out a lot of costs. We furloughed roughly 2,000 employees in our stores and about 400 of our team members in our corporate office and our fulfillment centers. And so as business returns, I mentioned in my prepared remarks, about 85% of our stores are back open. We are bringing back on our sales force. And so far, those stores that we brought back online, we’re seeing demand rebound or revenue written into the portfolio, which is our leading measure of sales effectively appears to be rebounding in those.

So we definitely want sales teams on our floors to capture that demand, collection volumes are up. So we need the labor in the stores to manage all that. We are, however, monitoring store by store. So where we have lesser demand, we’re scaling back on hours for our drivers in other areas where we can. But we want to be ready for the business, and we’re being prudent about how we look at the cost structure.

Bobby Griffin

Okay. I appreciate that. And then maybe as a follow-up to John’s question. For the Progressive side of the business, can you just remind us on what regions of the country your retail partners are more heavily weighted in, either the Southeast or West Coast or anything that might help us think about the impact of stay-at-home orders modestly getting lifted over the next couple of months?

Ryan Woodley

Yes. Given the increasing weight of the portfolio toward national accounts, it really is a case to case, border to border presence across our partners with what’s been a traditionally stronger weighting towards the south and in the southeast in terms of just penetration of rent-to-own generally. But we’re experiencing the sort of same patchwork of return to activity that others are as you look at varying state interpretations of federal guidance and return to general levels of returning to activity. So it’s going to be sort of a patchwork of that as we come through, but the net effect of it is increasing the return to kind of growth.

Operator

The next question comes from Brad Thomas of KeyBanc Capital Markets.

Brad Thomas

Just jumping right into it, Ryan, I wanted to talk a little bit about the trends and invoice volume and making sure we’re connecting it properly to how we think about the income statement. You gave a lot of numbers in your prepared remarks about the invoice volume having been up over 20% and then down over 20% and then improving. So I guess, are these basically like weak increments you’re giving us? And so are we sitting here with 2Q to date running down on kind of a weighted average basis? But that week-by-week, we’re seeing growth. And so if the trend of the last week or 2 continues, we could see invoice volumes up for 2Q? Am I interpreting that right?

Ryan Woodley

Maybe let me step back a little bit and sort of give a bigger picture and then we can zoom in for some of that detail because I think it will help put the context. So we had really strong revenue growth in Q1, that actually was the strongest growth we’ve had in 6 quarters. And the reason we had that strong growth in Q1 was obviously because we had seen such strong growth in invoice leading up to it, 34% in Q4. So Q1 benefited in large part, not only because of the uninterrupted January 1 to March 15 performance, but also because it was coming on the tail of such strong prior invoice growth. So that really aided Q1 performance, obviously. And then the drop-off in invoice only had so much time to impact Q1 results.

So Q2 will experience the brunt of the impact of the invoice reduction versus plan. And that will begin to more significantly impact revenue.But you won’t feel it more fully until Q3 when you have the impact of a lower invoice in Q2 bleeding into revenue in Q3. So that’s sort of the bigger picture of the trends that are influencing what you see an invoice and how that translates into revenue. What we are trying to do is give you a little bit more precise insight into what invoice was doing for the periods that John laid out because those are really the periods of movement and material movement. And we said through March 15, invoice is doing well, growing 21% year-over-year.And in that interim period of impact before stimulus at 315 to 415 roughly, it was down 26% year-over-year as there was a lot of uncertainty in store closures, show enclosures.

And then when stimulus hit mid-April, through the year, we’re kind of talking about trends capped at the end of April, mid-April, through the end of April, you saw that recover significantly from down 26 to only down two. And I guess the insight that I just provided in my response to the prior question was, it’s continued to improve from there now into the positive range.

And that’s — that leaves us with quite a bit of optimism.I think the caveat we provided is, it’s just impossible to know the extent to which that continues to be supported by stimulus and how much its stimulus tails off, we’ll continue to see increasing return to demand just because we’re seeing increasing returns to levels of activity as state home orders get lifted. Hopefully, that helps.

Brad Thomas

Got you. That’s helpful. So if we were to extrapolate out the trends you’ve been seeing in the last couple of weeks, would it be reasonable to think that that invoice volume could settle out to being somewhere in the neighborhood of flat for 2Q in a world where, again, you’ve added new doors year over year and the partners you’re working with are starting to reopen? Or is that just too much of a hole to dig yourself out of after a tough period of time at the end of March and the beginning of April?

Ryan Woodley

Yes, I think it would be perhaps unrealistic to think that you’d overcome being down 26% for that period. Not providing specific insight on guidance for Q2, obviously, because so much is so yet unknown, just a comment there is I think the biggest impact I expect to have to current Q2. But again, caveat. There’s still a lot of uncertainty out there about how this plays out.We’re just cautiously optimistic.

Brad Thomas

I appreciate that. Just making sure we’re all getting on the same page on how to connect it out on some of these numbers. Maybe just lastly for me, if we could — if you could give us a little more context on the bad debts and the write-offs? And I know there’s a lot of unknowns here. But can you remind me, does that — if you’re experiencing elevated bad debt, is that going to result in us needing to take a bigger haircut as we try and triangulate the invoice volume into a revenue number in our models? And then, I guess, is there anything that you would think at this point in terms of the likelihood that the — your ability to collect gets better or worse with what you’re seeing here really?

Ryan Woodley

So on bad debt, we, obviously it doesn’t get as much attention now that it’s factored into our presentation net revenues sort of above the line. But just since you thought of that because of the impact that it has on the translation from invoice to net revenue. So for Q1, bad debt was, I believe, 10.4% of gross revenues compared to 9.7% last year. But if you back out the effect of that incremental provision on bad debt, it was 9.8% of gross revenue, meaning that as we book the provision in the ordinary course accounting for current levels of delinquency, it would have been 9.8%.

So just right in line with last year. So we’re saying, as we package Q1 and report out on it, we’re right in line with where we were last year, reflecting current levels of delinquency. And so you step back from that and then say, is it reasonable to assume that payment trends will continue as they will in light of increasing levels of unemployment and other macroeconomic trends? It’s unlikely that you would expect to have no impact whatsoever on our customers’ future ability to pay.

And so we’re trying to reflect that in these incremental reserves that we’ve booked. So the idea is that when you do that, you’re sizing it appropriately so that you don’t need to further build that reserve in the future. But it’s impossible to do that exactly right without knowing the future, obviously. So we make our best guess.

And obviously, if we are a little conservative, we’ll leave that reserve over time. If we’re a little aggressive, we’ll have to build it. But the goal was to get it as close to accurate as possible. It’s close to an accurate representation of the potential future impairment.

Operator

The next question comes from Anthony Chukumba of Loop Capital Markets.

Anthony Chukumba

Two quick questions. First one just in terms of e-commerce, just any kind of update there. I would expect that you probably saw a pickup with shelter in place in which the showroom is close, but would love any update you can provide there.

Douglas Lindsay

Yes. Anthony, it’s Douglas. So we’ve seen a big pickup in e-com over the last quarter as you would expect, more of our existing customers, customers who were previously going into our showrooms were doing business online in April with our stores closed. Interestingly, as we begin to reopen stores, we saw that e-com traffic continue to be up and accelerate towards the last part of April.

So even in the states where we’re opening, we’re seeing a lot of strength in April, at the last part of April, and that’s continuing into May in e-comm. So we’re really happy, really happy we had all the framework in place and the technology in place. I think we get better and better at that every day, seeing higher traffic on our site and higher conversions. So really proud of the team. And too early to tell if that’s going to be sustained, but we’re happy with the performance so far.

Anthony Chukumba

Got it. That’s helpful. And then just a quick follow-up. Is there anything that you’re seeing on the virtual part of the business or the Progressive part of the business in terms of the competitive landscape? I just think that, obviously, we’ve talked many times about the fact that you have dozens and dozens of these little sort of competitors, a lot of them are backed by private equity, and I would have to imagine they’d be suffering mightily in this environment.

But I was just wondering if there’s anything that you guys were hearing out there in the channel?

Ryan Woodley

Yes. I appreciate the question. We may have heard similar rumors about difficulties being experienced by others in the market. But we’ve all had a lot to focus on over the last 8 weeks. And I would say it continued, there continues to be pretty tough competition in the market. And we wouldn’t be doing the right thing if we didn’t continue to take that seriously, which is one of the big reasons why we haven’t pulled back on some of our important investments and growth initiatives like e-com and mobile as we move forward, even in this environment because there’s just so much potential out there.

And look, the fact that there’s, I think we should expect to continue to see strong competition, and that’s just a natural result of a really large remaining market opportunity. Just, not just share shift, but greenfield that remains out there. Retailers who have not yet implemented rent-to-own and the significant portion of 1/3 of the U.S. population that could still benefit from rent-to-own because they’re underserved. So I think that’s going to continue to support strong competition in the market, and we’re investing to maintain our lead.

Anthony Chukumba

Got it. And if I can just sneak one more, and I hate to be that guy. But just remind me something that you said. Have, what have you seen in terms of the pipeline, particularly given the fact that you have a lot of retailers who are obviously struggling mightily. I would think that, that would be helpful to you in terms of building out the pipeline, maybe they’re a lot more receptive to adding nonrecourse for into owned solution, given the current sort of macroeconomic headwinds? I promise that’s my last one.

Ryan Woodley

That’s a good question. We debated this at the onset of the pandemic because there were these sort of competing factors. One, there was just the level of uncertainty and what that would do to folks desire to make plans and make investments, sort of offset by the strong desire to serve a customer who was going to benefit from the flexibility of lease-to-own and knowing that there would be tightening above us and that may be a tailwind going forward that, that might further increase demand in the pipe. So I may have been, I may have thought it would slow down more, but it actually hasn’t. As I sit here today, I think the pipeline looks better today than it did in early March. So I’m really happy with where we sit right now. We’ve already had a couple of wins and continue to be optimistic about the potential future growth that could come from those.

Operator

The next question comes from Bill Chappell of SunTrust.

Bill Chappell

I guess first question just on the Progressive side. Trying to understand if, and I realize it’s too early to tell, but kind of your retail customers, if you see any risk out there of them going away, some of the smaller ones or struggling ones and if you’ve kind of factored that in over the next few months. And then conversely, again, I understand it’s early, but typically, this is a time where retailers are looking for incremental dollars over the next few months. And so have you seen more interest as some are coming back to you who have been in project mode or what have you and wanting to move forward?

Ryan Woodley

And by interest, you mean pipeline activity? Or do you mean among —

Bill Chappell

Exactly. Pipeline activity that’s maybe people have pushed you off in the past, but now say, hey, this does sound like something, especially if we go into a recession that we could want to add to our business. If it’s heated up or again, there’s been so much turbulence, it might be too early for that.

Ryan Woodley

Yes. So it’s a decent-sized pipeline. So there — I’d say there are puts and takes inside of it. But on the whole, I’d just reiterate the statement that I feel like it’s — I’m more excited about it now than I was in early March.

We’ve had some wins. And I’m excited about the growth that could come from stuff that we have moving through the pipeline. So it’s better than I expected, heading into COVID, which is a good position to be in. And then, I’m sorry, Bill, what was your first question?

Bill Chappell

Just kind of with regard to the health of your existing customers. Are you worried about any of them going under?

Ryan Woodley

Got you, the partners. We have a base of several thousand partners. So I expect that we’ll see the gamut of sort of outcomes from the pandemic, and I guess it would be naive to say that across several thousand retail partners that we wouldn’t have any that go out of business, especially in the long tail of those partnerships. So I imagine that will occur down there.

But where I sit today, I feel pretty good about the strength of those partnerships and the ability to generate future growth.

Bill Chappell

Got it. And Douglas, just any kind of early read for — in the showrooms that have been reopened? Have you seen pent-up demand? Have you seen people actually show up? I mean I know it’s — you know in Georgia, we’re kind of leading-edge on these things, and people are ready to get out and about, and so just didn’t know what you’ve experienced so far?

Douglas Lindsay

Yes. I mean I think we — I think Brian, I bet, did some work on the call of really breaking it up in time period. So it say after April 15, checks began to come out and we began to open showrooms on April 23. So what we saw was a surge in customer payments that lasted to the end of the month, and we’re continuing to see that going into May.

So that’s positive, a lot of cash coming in the door. Customers have a lot of cash. And they’re buying, and they’re making their payments, which is encouraging. So our deliveries have been strong in the stores that we’ve reopened.

We’ve got a phased reopen going on, and we’re — that we initially opened two states then continue to open up to 85% of our network. In those stores that we’ve reopened, we are tracking to our original plan that we put out at the beginning of 2020. But probably more importantly, we’re driving a lot of e-com. So e-commerce is way up, as I said in my prepared remarks, in the month of April.

And that as a percent of our total deliveries is a significantly higher number than it’s been in the past. So we’re really bullish about that.

John Robinson

One thing I’d add to that, Douglas was exactly right. The only thing I’d add is, interestingly, even in the stores, the showrooms that have reopened, Bill, as you remember, e-com, we service through our stores. And so the e-commerce remains strong in those. So even after the showrooms open, which is an encouraging sign. We don’t know what, as Douglas said earlier, we don’t know if that speaks to a trend. But it’s an interesting fact that the e-com business has been strong and remains strong even when the showrooms have reopened.

Operator

The next question comes from Kyle Joseph of Jefferies.

Kyle Joseph

Most of my questions have been answered, but just a few follow-ups here. I’ll start with Ryan, if I may. Ryan, can you give us a sense for the revenue breakdown at Progressive between e-commerce and brick-and-mortar and how you see that trending over time? And then on that note, can you give us any sort of update with the new nationwide retailers you partnered with, where you are on being able to offer an e-commerce solution there?

Ryan Woodley

Sure. Happy to, Kyle. So we don’t split out e-com or, from brick-and-mortar when we talk about results. But I will offer the insight to add on to what Douglas had shared earlier. We’re seeing similar trends. So among our native e-com partners, we’re seeing strong performance, especially in the context of COVID.

As you can imagine, they’re benefiting from that shift to online and doing very well. And even among our omnichannel providers, we’re seeing the same thing. So we’re seeing very strong double-digit increases in application volume through those channels, which is a really good thing to see. And if there was, it’s maybe inappropriate to say, but if there is a silver lining in a crisis like this, it’s been the significant focus on accelerating digital initiatives across our portfolio and among some of our larger accounts, there’s, there was a focus prior to COVID, but this has served as a catalyst for their focus and investment on getting those new sources of application, new integrations develop.

So that’ll be a silver line coming out of this is the advancements that we’re going to make on that front. As you know, that’s an area we’ve been investing in for quite a while now, and we expect it to be a significant component of our future growth and the trends we’re seeing are positive and the advancements that are being made on that front are likewise positive.

And then on your second question on national partnerships. I mentioned in the prepared remarks that up until March 15th, tracking right in line with expectations going well, great relationships with those partners. And the only thing that’s changed is the deflection in invoice growth among some of them as a result of closed stores and/or showrooms. Those that have remained open are doing well. And I feel like we’re seeing, I feel like we are seeing increasingly positive trends there, and I expect that to continue.

Kyle Joseph

Got it. And then one follow-up for you, Ryan. I think I know the answer, but I’d rather hear it from the horse’s mouth. Given the invoice volume you guys had in January and February, I think you said it was just north of 20%. Obviously, that’s down versus the fourth quarter. Is that more driven by retailer seasonality than an actual, what drove that? My guess, it would be retail seasonality.

Ryan Woodley

Yes. You got it. That’s it. The Q2 is just the selling season for big categories like electronics, even mobile and jewelry, they’re doing well in that period. And so it was just going to be that irrespective of COVID.

Kyle Joseph

Okay. That’s helpful. And then last question for me. Over to Douglas. Seven back with, call it, a month plus of store closures and looking at your performance during that time, has it changed your perspective on the long-term outlook for the number of stores or potential consolidation activity? And given the success of the e-commerce platform, any sort of long-term outlook changes you’ve seen there?

Douglas Lindsay

Yes. I mean, listen, the way we’re thinking about it is we’re taking effectively a digital-first strategy, where we’re trying to do things in the business that we can scale quickly. I think RTO was a good example of that. How do we like put things at scale in our network and drive a better customer experience, control decisioning, control risk and have a better outcome for us. So with the digital-first sort of focus comes sort of this competitive advantage we have with stores, we believe that we really should have fewer stores in the network, but higher volume stores. And so what you’ll see from us going forward is more, I would say, 2 store in the 1 store type moves. We think we can do this at a lower cost, drive greater earnings and have really good cash flow dynamics from that.

Operator

The next question comes from Vincent Caintic of Stephens.

Vincent Caintic

So first on the Progressive. I just wanted to follow-up on some earlier, on an earlier question. Just on the number of doors that are open, I guess, if you could maybe let us know when volume was down, I think the worst was 26%, when it was down at that level, how many doors were closed at that time? And then where are we now? And are there any sort of discussions you’re having with your retail partners, where it seems like maybe 100% of the doors might be opened by, let’s say, summer or so? Like any sort of a forward look there?

Ryan Woodley

Sure. Yes. We don’t have exact counts just because of the volume in the tens of thousands, it’s hard to track that discretely by period. But I’ll just give you an example of the key movers. So in our jewelry vertical, obviously, those showrooms were closed entirely. Many of those in mall-based locations where the entire model is closed. And while the vast majority of those remain close to this day, we are seeing the beginnings of reopening there. Now we’re in the early stages of that, and I expect that to continue gradually to reopen, again, in response to the lifting of state home orders. Electronics is another example where showrooms were closed, and there was a lot of curbside service worked on to facilitate curbside service, and I expect that will move to gradual reopening process with limits on the number of people allowed in the showroom and then that eventually evolving into open showrooms. But those two examples are examples where showrooms remain closed. But we are — we have already seen the beginnings of the reopening process, and we expect it’ll reoccur gradually, that’s not going to be a one week to the next, as you pointed out. It’ll be over a period of several weeks.But in spite of that, we’re seeing that recovery in invoice, which is what’s interesting. So it’s obviously being driven by several factors there.

Vincent Caintic

That’s really helpful. Second question, I’m sure both on the Progressive side and on the Aaron’s business side. Just wondering what sort of levels are baked into the reserves that you’re taking, I guess, not necessarily a forecast of how bad can reserve — can bad debt get, but sort of what’s — what levels can you absorb and be fully covered by your existing reserves? And maybe relatedly, do the reserves bake in any thoughts about depreciation rates and how you’re thinking about return to inventory volumes, so pickups of volumes?

Steve Michaels

Yes, Vince, this is Steve. I mean as we said in the prepared remarks, and as Ryan said, we obviously looked at the balance sheet date. As of March 31, we looked at our lease impairment reserves and our bad debt allowances and decided or made the determination that it was unlikely to assume that COVID would not have some impact on the future. And once you make that kind of — from an accounting standpoint, you make that potential impairment analysis, then you move on to like, well, how do you quantify it and you have got a probability weight different outcomes.

We’ve got this government stimulus that we don’t know how the immediate $1200 checks and the actual checks are going to continue to play out. We’ve got enhanced unemployment benefits that currently last until the end of July, but there’s — we have no knowledge of whether those will be extended. So we just had to use all of the information that we had available to us, along with the actual results that we’ve been seeing kind of post the quarter and make our best determination about potential future outcomes.

As Ryan said appropriately, we’re not going to be right, right? Because we don’t know the future.But at the time, our best estimates were to take these incremental reserves, and they were basically applied against the valuation of the lease merchandise that we have on the balance sheet and then the amount of the AR reserves or the AR that we have on the balance sheet. So it’s not reflected as a percentage of how many customers we think are going to go bad or anything like that. It’s just — it’s an overlay against the reserves that we would have had anyways based on the information we had available to us when we were making the decision.

And then obviously, part of the reserve is a CECL reserve, which refers specifically to our Vive business, which is a second look credit provider that partners with banks, and we had to adopt CECL as of January 1.As you know there, we had about a — historically, we ran about a mid-teens provision expense under the previous provisioning method, and after adopting CECL, we expected that we’d be kind of in the low to, call it, mid-20s, and we were after we took the day one retained earnings charge from the adoption of CECL. Because of macroeconomic factors related to that CECL calculation, we ended up taking additional reserves in the quarter that put us into the low 30s percent from a provision expense, and that is heavily weighted on future expectations of unemployment rates and GDP. So that was about $7 million of the additional incremental reserves that we took.

Vincent Caintic

Okay. That’s very helpful. Maybe have you seen a lot of return items or request for returns by customers?

Douglas Lindsay

This is Douglas. We’ve actually seen lower return levels in the first quarter and going into April than we have experienced historically. And I think there’s multiple reasons for that. I think we’re working with the customer more through this crisis and making sure that they can stay on the product and that we fulfill our value proposition for being flexible with them. Second is that the customer is really not trading out product right now.

A customer rent-to-own typically will buy something and then trade up or trade out into something different. They’re just not leaving their homes right now. And I think lastly, there’s just more liquidity in the market. So customers are able to stay in their payments longer and get towards ownership. So we don’t expect, I expect to see lower returns over the near term as liquidity is in the market, and the more payments they’re making in their leases, I think, more likelihood that they go to further into ownership.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to John Robinson for any closing remarks.

John Robinson

Thank you. I want to thank our associates, franchisees and retail partners for your commitment to serving our customers during this time of crisis. It’s definitely been a tumultuous period. And our sympathy goes out to all of those who’ve been negatively affected by this pandemic. We thank you all for your participation on our call today, and we look forward to updating you again on our second quarter call.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.





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Kopin Corp (KOPN) CEO John Fan on Q1 2020 Results – Earnings Call Transcript


Kopin Corp (NASDAQ:KOPN) Q1 2020 Earnings Conference Call May 5, 2020 8:30 AM ET

Company Participants

Richard Sneider – Treasurer & CFO

John Fan – Co-Founder, Chairman, CEO & President

Conference Call Participants

Glenn Mattson – Ladenburg Thalmann & Co.

Operator

Good day, and welcome to the Kopin Corporation First Quarter 2020 Earnings Conference Call. Today’s conference is being recorded.

At this time, I would like to turn the conference over to Richard Sneider, Chief Financial Officer. Please go ahead, sir.

Richard Sneider

Thank you, Operator. Welcome, everyone, and thank you for joining us this morning. John will begin today’s call with a discussion of our strategy, technology and markets. I will go through the first quarter results at a high level. John will conclude our prepared remarks, and then we’ll be happy to take your questions.

I would like to remind everyone that during today’s call, taking place on Tuesday, May 5, 2020, we will be making forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on the company’s current expectations, projections, beliefs and estimates and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those forward-looking statements. Potential risks include, but are not limited to, demand for our products, operating with well our subsidiaries, market conditions and other factors discussed in our most annual report on Form 10-K and other documents filed with the Securities and Exchange Commission. The company undertakes no obligation to update the forward-looking statements made during today’s call.

And with that, I’ll turn the call over to John.

John Fan

Good morning, and thank you for joining us to discuss our first quarter results. Given the unprecedented circumstances we are facing, I want to start by expressing my hope that all of you and your families are staying safe and well.

Before I discuss our strong start to the year, I first want to review our response to COVID-19, and how it has impacted our business. Like all companies, in March, we quickly shift our employees to remote work where possible. Our teams adjusted quickly and that structure has worked well. But as a defense-related company, we have many employees considered essential, and they have continued to work every day. I cannot tell you how grateful I am to this group, their positive attitude and their commitment to see Kopin succeed. While our AMLCD products are making a Class 10 cleanroom, which provide an inherent level of safety and protection with mask, gloves and goggles. We did take extra precautions. The COVID thing has varied and is directly responsible for a strong first quarter, and the momentum was carried into second quarter. We have had a very good start to the year with demand holding steady. Our suppliers keep us in stock with only a few minor bumps and interruptions. Our dedicated employees keeping the business on track and are performing.

We are very pleased with the results. In particular, our defense business is strong with product revenues increasing 144%. In the enterprise sector, our core applications area has slowed recently. Others have remained strong, particularly in the — for the safety. Our total revenue increased about 42% compared with the first quarter of 2019. In addition, we have reduced our R&D and SG&A expenses by 49% and continue to look at ways to streamline our cost structure. We expect momentum to continue in the second quarter, barring any surprises for either customers or suppliers or unless there is some unexpected change in the circumstances with the workforce related to the COVID.

We continue to shift under our 2 defense production programs: The FWS-I program and also the F-35 Joint Strike Fighter program. We recently announced another 4 on order for the F-35 program, which now includes shipments into 2021. The 5 highest F-35 jet was delivered in the past March, with the DoD expected to purchase a minimum of 2,400 jets over the life cycle of the program. And there are also international markets for F-35. U.S. airlines is expected to purchase hundreds of jets in the coming years. So it is still really early days in Kopin’s monetization of F-35 profile opportunity.

We also see continued progress on our defense-related development programs where we have more than 10 programs in various stages of development, while some of them may not contribute significantly to product revenues for the next year or 2. In fact, not all will reach production after moving to development. It is by far the strongest defense program portfolio in our history. And obviously, our interests here for the program to evolve into full-scale production programs that utilize our technologies. In almost all these programs, our micro displays are the only space chosen.

As previously mentioned, we have streamlined our internal R&D activities to focus on our core micro-display business. In particular, our current R&D investments are primarily focused on our organic light-emitting diode, or OLED displays. At the Consumer Electronics Show in past January, we demonstrated the world’s first monoclone double-stack OLED, which is emits more than 20,000 nits. We also demonstrate our early samples of the world’s first full color 2.6k, 1.3 inch diagonal OLED displays using our proprietary double-stack technology. In addition, in the first quarter, we’ll receive our full production order for our OLED backside wafers, which we expect to begin shipping in late second quarter of 2020.

An interesting effect of the COVID-19 situation, wearable headset customers see their products being used in hospitals and in areas of high infections by medical and public-safety responders. Enterprises are accelerating their use of AR as companies looking for ways to train people and work collaboratively in a socially distant environment. Remote collaboration and remote training are all gaining acceptance. These applications are demonstrating the power of technology in allowing collaborative responses by minimizing the number of people on site. The global pandemic is driving increased interest in AR and VR technology for all customer segments, defense, enterprise and in consumers. Interest for a number of customers in this area has remained very strong for our micro-displays, particularly for our micro OLED displays. So it’s not clear at this time how quickly this customer engagement will converge to prior levels. While we are experiencing unusual high sales risk, we believe our strong defense business, OLED micro-displays development activities and continued emphasis on efficiently managing our cost structure to carry our momentum into the second quarter.

Now I’ll return the call to Rich.

Richard Sneider

Thank you, John. Turning to our financial results. Total revenues for the first quarter of 2020 were $7.9 million compared to $5.5 million for the first quarter of 2019, an increase of 42%. Cost of goods sold for the first quarter of 2020 was $5.6 million or 95% of product revenues compared with $5.9 million or 127% for the first quarter of last year. The decrease in cost of product revenues for 3 months ended March 28, 2020, as compared to the 3 months ended March 30, 2019, was primarily due to improved manufacturing yields and higher volumes, which reduced fixed cost per unit at our U.S. plant, partially offset by lower manufacturing efficiencies at our Scotland plant, caused by some supply issues.

R&D expenses in the first quarter of 2020 were $2.3 million compared with $5 million in the first quarter of 2019. The lower R&D costs for the first quarter of 2020 as compared to the prior year was a result of curtailment of certain programs. SG&A expenses were $3.4 million in the first quarter of 2020 compared to $6.3 million in the first quarter of 2019. The decrease was primarily due to a decrease in compensation expenses, including stock-based compensation, bad-debt expense, professional fees, information technology expenses and the accretion of the endless continued consideration. Other income/expense was expense of approximately $86,000 for the first quarter of 2020 compared with $300,000 of income for the first quarter of 2019. During the 3 months ended March 28, 2020, we recorded $200,000 of foreign currency losses as compared to $200,000 of foreign currency gains for the 3 months ended March 30, 2019.

Turning to the bottom line, our net loss attributable to controlling interest for the quarter was approximately $3.6 million or $0.04 per share compared with a net loss of $11.3 million or 15% — $0.15 per share in the first quarter of 2019, a 68% improvement. Cash and marketable securities were approximately $17.6 million at March 28, 2020, compared with $21.8 million at December 28, 2019. Subsequent to the end of the quarter, we received a $2.1 million Payment Protection Plan loan under the CARES Act, which is not included in the $17.6 million cash position as of March in 2020. We currently do not have plans on raising additional capital. First quarter amounts for depreciation and stock compensation are attached in the table to the Q1 press release. The amounts discussed above are based on current estimates and listeners should review our Form 10-Q for the first quarter of 2020 for any possible changes and additional disclosures.

Finally, with regards to the NASDAQ minimum listing requirements, we have until December 2020 to regain compliance.

Operator, we’ll now take calls.

Question-and-Answer Session

Operator

[Operator Instructions]. We’ll take our first question from Glenn Mattson with Ladenburg Thalmann.

Glenn Mattson

Nice to see the good results. I’m curious on the enterprise side. Just kind of, I guess, a couple of things. First of all, is the thermal-imaging technology that you have, can that be — is there an application for that as far as judging people maybe at high temperatures from a distance? And is there any possibility for an uptick in that?

And then secondly, I’m curious just about, in general, the fire and safety and the first responders part of the business. I know that’s had a big portion of the Q4 revenue. And just curious as to the breakdown between that versus some of the more industrial applications in the current quarter.

Richard Sneider

So we have talked to some of our customers, and there are folks experimenting with thermal applications as kind of a first line of defense when people are coming into a building to identify their temperatures and so on and so forth. I don’t know if any of that was actually implemented that, but they have talked about that extensively. And sorry, man, what was the second piece of the question?

Glenn Mattson

Yes, sure. Just on the fire — first responders for fireman, people like that, just the breakdown between that versus the more industrial applications on the enterprise side?

Richard Sneider

So in both Q4 of last year and Q1 of this year, we had a significant increase in volume in that application. As we’ll say in the 10-Q tomorrow when we file it — that we anticipate filing it, we don’t expect the run rate that we had in Q1 to continue through the year. I don’t know if it was just them filling some of the supply chain or what have you, but it was a very good quarter for that application.

Glenn Mattson

Okay. And curious on the gross margin, it was down a little sequentially. I guess that’s more — as the business gets a little more heavily weighted towards defense, can you talk about the outlook for gross margin for the rest of the year?

Richard Sneider

Yes. We continue to see yield improvements during the course of the year and hopefully, higher volumes and all of that will result in improved gross margins. The product revenues were slightly down in the quarter sequentially, which is why the gross margin was down slightly sequentially. It’s the fixed cost per unit aspect of it.

Glenn Mattson

Right. Great. And then just on last on sales and marketing. Do you expect that this level is kind of a baseline from here? Do you expect it to grow significantly as you try and penetrate more enterprise allocations, things like that?

Richard Sneider

Yes. That $3.8 million to $4 million is kind of the baseline that we’re shooting for. The wildcard there is only stock compensation, which can be affected by the stock price, obviously. But on the noncash front — on a cash basis, I guess, we would expect it to be in that type of level.

Question-and-Answer Session

Operator

[Operator Instructions]. And it appears we have no further questions at this time. I’d like to turn the conference back to Dr. John Fan for any additional or closing remarks.

John Fan

Thank you for joining us this morning, and I hope to talk to you in the next call. Bye, bye.

Operator

And that does conclude today’s conference. We thank you for your participation. You may now disconnect.





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Hill-Rom Holdings, Inc. (HRC) CEO John Groetelaars on Q1 2020 Results – Earnings Call Transcript


Hill-Rom Holdings, Inc. (NYSE:HRC) Q1 2020 Results Conference Call May 1, 2020 8:30 AM ET

Company Participants

Mary Kay Ladone – SVP, Corporate Development, Strategy and IR

John Groetelaars – President and CEO

Barbara Bodem – CFO

Conference Call Participants

Larry Keusch – Raymond James

Rick Wise – Stifel

David Lewis – Morgan Stanley

Bob Hopkins – Bank of America

Kristen Stewart – Barclays

Matt Taylor – UBS

Operator

Good morning. And welcome to Hillrom’s Fiscal Second Quarter 2020 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. At the end of management’s prepared remarks, we will conduct a question-and-answer session. [Operator Instructions]

As a reminder, this call is being recorded by Hillrom and is copyrighted material. It cannot be recorded, rebroadcast, or transmitted without Hillrom’s written consent. If you have any objections, please disconnect at this time.

Now, I’d like to turn the call over to Ms. Mary Kay Ladone, Senior Vice President, Corporate Development, Strategy and Investor Relations. Ms. Ladone, you may begin.

Mary Kay Ladone

Good morning, and thanks for joining us for our Fiscal Second Quarter 2020 Earnings Conference Call. I hope everyone is healthy and remaining safe during these challenging times. Joining me today are John Groetelaars, President and Chief Executive Officer of Hillrom; and Barbara Bodem, Chief Financial Officer.

Before we get started, let me begin by reminding you that this presentation includes forward-looking statements that are subject to risks, uncertainties, assumptions, and other factors that could cause actual results to differ materially from those described, including any impact related to the COVID-19 pandemic. Please refer to today’s press release and our SEC filings for more information concerning risk factors that could cause actual results to differ materially.

In addition, on today’s call, non-GAAP financial measures will be used. Reconciliations between GAAP and non-GAAP financial measures are included in our earnings release issued this morning. I would also like to mention that in addition to the press release issued this morning, we have posted a supplemental presentation, which includes highlights on Hillrom’s response to the current pandemic. These materials can be accessed on the Investor Relations page of our website.

So, with that introduction, let me now turn the call over to John.

John Groetelaars

Thanks, Mary Kay. Good morning, everyone. And I hope you, your families and friends are all safe and healthy. It goes without saying that we’re living through an unprecedented and challenging times related to the COVID-19 global pandemic.

Before we get into the details of the quarter, I wanted to take a moment to thank our entire Hillrom team for their unwavering commitment and extraordinary contributions to support our customers, front line caregivers and patients in our united fight against this virus. Hillrom’s mission of enhancing outcomes for patients and caregivers has never been more vital to the delivery of health care. Our positive culture has never been more inspiring and our global response, nothing short of impressive on multiple fronts. We are supporting those on the front lines by rapidly expanding production of critical care products. We have pivoted our R&D efforts to introduce a spectrum of new products to meet the unique COVID treatment challenges, implemented a comprehensive business continuity plan to ensure minimal disruption of our global manufacturing operations and supply chain. And we’ve delivered approximately $6 million of support in the form of both, monetary and product donations to support our health care heroes, who are at the front lines saving lives.

Hillrom’s diversified businesses are a source of strength in these turbulent times. As a result, we have both, the ability and confidence to successfully navigate through the future environment. The combination of our exceptional execution, financial strength and diverse portfolio underscores our commitment to enhancing value for all shareholders today and over the long term.

Moving to financial highlights for our second quarter, we once again exceeded our guidance on both, the top-line and bottom line. These results demonstrate our ability to modulate risk and reinforces the critical nature of our product portfolio and our category leadership position in the markets we serve.

Core revenue growth was 6%, our eighth consecutive quarter of mid-single-digit growth. Core revenue includes a contribution of approximately 200 basis points from recent acquisitions, and a COVID-19 net tailwind of approximately $15 million that ensued toward the end of the quarter.

We continue to be pleased with significant margin expansion, achieving a record adjusted gross margin of 51.2% and operating margin of 18.3%. This resulted in an adjusted EPS of $1.28 per diluted share, an increase of 12% over the prior year. Our financial performance is supported by continued execution of our four strategic priorities. This is the foundation that allows us to respond globally, while positioning us for the long-term. Growth from new products accelerated in Q2.

On a year-to-date basis, we’ve now achieved more than $260 million in new product revenue, an increase of nearly 30% to last year. Importantly, we continue to anticipate full year new product revenue of approximately $550 million.

I’m proud about how our R&D teams rapidly responded to the challenge of developing five new product innovations for COVID-19 patients. In addition to receiving emergency use authorization to enhance our MetaNeb System for respiratory support, we’re also pleased to offer new mobile communications and remote monitoring solutions for vital signs measurements that will help protect caregivers and reduce the overall demand for PPE as they deal with this virus.

Geographically, our U.S. performance was very strong with all three businesses contributing to core growth of 8%. We also saw improved international performance with core growth of 3%, which was better than expected. This was the result of strong international COVID-related demand for products like ICU beds and thermometry, which more than offset the expected impact from the timing of large capital projects in selected markets.

All regions except EMEA had positive results, including double-digit growth in Latin America, Canada, and Asia-Pacific. As you know, we turned on key investments in China last year to enhance our position in emerging markets. This quarter, we once again achieved growth in China of more than 20%, validating our strategy and investment plans. While we expect to see some near-term choppiness as a result of the pandemic in China and other emerging markets, this will continue to be a key driver of our longer term growth strategy.

Let me now turn to Q2 performance by business at constant currency rates. First, Patient Support Systems revenue grew 7% and core growth was 8%. The majority of the early COVID-19 related demand benefited this business. In the U.S., core growth of 9% was supported once again by contributions across our broad portfolio of connected care solutions and services. This included double-digit growth from med-surg bed systems, including the Centrella Smart+ Bed and Care Communications.

Core international growth in this business was 5% and was largely the result of significant demand for Hillrom ICU beds, particularly from Canada. In Front Line Care, Q2 revenue advanced 7% with strong growth, both in the U.S. and internationally. This was the result of new products and broad-based global strength across the Welch Allyn vital signs times monitoring equipment, like thermometry and blood pressure monitoring, and certain respiratory health products, including the MetaNeb System mentioned earlier, and our Life2000 non-invasive ventilator.

Lastly, Surgical Solutions revenue declined 25%, reflecting the impact of the surgical consumables divestiture last year. Core revenue declined 3% as U.S. growth of 9% was more than offset by the expected decline in select international markets related to the timing of large capital projects that we discussed on our previous call.

So, now, with that as the backdrop, we look to the future with an eye toward disciplined execution of our priorities, adapting to the current environment to support our customers while advancing our mission. No company including Hillrom will be completely immune from this new reality. All health care companies will be faced with challenges, and the global macro environment may continue to pose obstacles for some period of time. The net impact to Hillrom in various regions and product categories will largely depend on the scope, intensity and duration of this pandemic, as well as the shape of the recovery and the demand for health care. These new variables weigh on our ability to predict outcomes. So, we have elected to suspend our previously issued guidance. However, we thought it was important to share our point of view and provide transparency on the current environment and dynamics, and the visibility we have our businesses as of today.

From a demand perspective, our diverse portfolio represents a significant advantage due to built-in hedging. Some parts of the business are facing challenges, while others are resilient or performing at high levels to meet significant demand. We currently expect approximately 40% of our business to experience challenges related to installations and project delays where hospital access is a requirement or where lower physician office visits may impact results. These dynamics primarily affect Surgical Solutions, Care Communications and physician-oriented portions of our Front Line Care portfolio. We expect growth for this category of products to collectively decline by more than 20% in the second half of the year. However, we also believe it is fair to assume that starting in the fiscal fourth quarter, our access into hospitals for new installations will resume in a large majority of sites, and patient access to primary care physicians will gradually return.

The remaining 60% of Hillrom’s portfolio is fairly resilient to the current dynamics, including approximately 40% of the portfolio that is supporting higher demand. This, of course, comprises of our smart bed portfolio, portions of our respiratory care business and other devices and tools, aiding caregivers on the front lines to diagnose, monitor and treat COVID patients.

As of today, strong demand for these critical care products continues. This reflects the strong Q2 order book and backlog for med-surg and ICU beds, our rental fleet and a variety of products within the Front Line Care business.

For smart beds, we achieved a record level of U.S. orders, more than double a typical quarter and representing nearly a 70% increase over Q1. We estimate that more than half of this growth represents new incremental expansion demand versus an acceleration or pull forward of orders that were already in our funnel.

A key consideration, as we look towards the second half and the future is the impact of this pandemic on the outlook for beds and other capital purchases by hospitals, local and national governments, including the state of preparedness related to another possible wave or planning for future potential pandemics. While there are multiple reports calling for additional bed capacity, which could fuel a multiyear global growth cycle, we do not have clear visibility on the longer term implications. Durability of increased demand is evolving dynamic that we will continue to monitor vigilantly.

From a supply perspective, we’ve doubled down on our efforts to increase capacity. Our Hillrom operations team is doing a tremendous job, quickly scaling our workforce by hiring more than 300 additional employees, shifting team members to high-demand products, while being very rigorous to maintain a healthy and safe work environment. Our team is monitoring, tracking and implementing countermeasures to proactively keep our supply chain moving and ensuring upstream parts availability.

I’m very pleased to report that we continue to have no material disruptions to our global manufacturing or supply chain operations. We continue on track towards doubling capacity for med-surg and ICU beds, and patient monitoring and thermometry where current demand far exceeds supply.

Lastly, we’re in the process of increasing capacity on annualized basis by greater than fivefold for our Life2000 non-invasive ventilator. This device is currently approved in the United States as a critical care and home care ventilator. It is ideal for support of patients with mild to moderate respiratory distress and for weaning from mechanical ventilation. Patients, such as those with COPD or COVID-19, may be eligible to use the product at home. Our capacity expansion will support our efforts to fulfill a $20 million order from Health and Human Services by this summer, and additional demand from other acute customers.

So, in summary, the entire Hillrom team remains committed to our mission, even during this time of great uncertainty. We believe we have the right solutions and strategies and are well-positioned to meet the immediate challenges before us. We look forward to providing you with continued updates as we position our Company for sustained success, and deliver enhanced value to all stakeholders.

Thanks. And now, I’ll turn the call over to Barb.

Barbara Bodem

Thanks, John. Good morning, everyone.

For the fiscal second quarter, we reported GAAP earnings of $0.70 per diluted share. These results include after-tax special items related to intangible amortization, acquisition and integration costs, and other special charges. Adjusted earnings of $1.28 per diluted share advanced 12% from the $1.14 per diluted share in the prior year period, exceeding our guidance range of $1.14 to $1.16 per diluted share. These results reflect solid core revenue growth, the impact of COVID-19 late in our quarter, ongoing margin expansion as well as strategic investments to drive long-term top-line growth.

Now, let me briefly walk through our Q2 2020 P&L.

We reported revenue of $723 million for the second quarter, which was an increase of 1% over the prior year revenue of $714 million. On a constant currency basis, revenue increased 2%. Core revenue advanced 6%, above our guidance of approximately 4% core growth. Acquisitions contributed approximately 200 basis points of growth and the net impact of COVID-19 revenue was approximately $15 million.

Turning to the rest of the P&L. Adjusted gross margin of 51.2%, represents a record level and reflects improvement of 180 basis points, with expansion across all three businesses. This reflects the positive contribution from product mix, new products, M&A and portfolio optimization initiatives and benefits of manufacturing costs and sourcing efficiencies. R&D spending at $34 million declined 6% over the prior year, primarily due to project timing. Adjusted SG&A of $204 million increased 2% as lower discretionary spending like travel, meeting and certain marketing expenses were more than offset by the impact of acquisition and IT transformation initiative. Adjusted operating margin was 18.3%, reflecting an improvement of 190 basis points, compared to the prior year.

Interest and other non-operating expenses for the quarter of $23 million included an unplanned impact from currency devaluation of approximately $5 million. The adjusted tax rate was 21% and adjusted earnings for the fiscal second quarter $1.28 per diluted share, increased 12%. Excluding the diluted impact of the surgical consumables divestiture, which contributed $0.06 per diluted share last year, adjusted EPS increased 19%.

Now, turning to cash flow. Cash flow from operations for the first six months of 2020 was $157 million, flat to prior year. Capital expenditures on a year-to-date totaled $46 million, $15 million higher than the prior year, driven by IT transformation costs and capitalized software costs related to R&D investments. As a result, year-to-date free cash flow totaled to $111 million.

Our balance sheet and overall financial position remains very strong. During the quarter, we raised our dividend for the 10th consecutive year. To-date, we’ve returned $99 million to shareholders through dividends and share repurchases during fiscal 2020.

Our debt-to-EBITDA ratio at the end of March was 3.3 times, and we ended the quarter with $291 million in cash. We continue to operate well within our debt covenants and have no material debt maturities until 2024.

And lastly, given our recent refinancing efforts last year, we have access to a revolving credit facility of upto $1.2 billion to address any capital needs as necessary.

Now, before turning the call back over to John, let me comment on our decision to suspend guidance.

First, it’s important to note that we are actively monitoring the evolving landscape and tracking the potential implications geographically and within each of our three businesses. We continued to see accelerated demand across some areas of the portfolio during April. However, we are now also experiencing some project delays, primarily in Surgical Solutions, Care Communications and certain areas of Front Line Care due to lower physician office visits.

As a result, and given the ongoing uncertainties, scope and evolving nature of the pandemic, we are not in a position to reasonably estimate the net impact of these dynamics on our future financial performance at this time. We would also not recommend extrapolating our recent results into projections for the remainder of the fiscal year. We look forward to providing you with additional updates in the future.

Thanks. And with that, I’ll turn the call back over to John.

John Groetelaars

Thanks, Barb.

I’d like to close our prepared remarks this morning by reiterating our commitment to Hillrom’s mission and strategy. The value of our diverse product portfolio, ability to rapidly innovate and adapt and our response to the current crisis provides positive assurance in our ability to execute in times like these.

Our balance sheet is strong and affords us the optionality to continue to invest in our strategic priorities, including new product innovation, emerging market growth and acquisitions. We are fortunate to be well-positioned to play a pivotal role in the global response to COVID. And we remain focused on our longer term growth prospects that will add further value to health care delivery.

Of course, none of our success would be possible without the hard work and dedication of our entire Hillrom team. I am humbled and inspired by our employees’ consistent dedication and extraordinary efforts. On a daily basis, I receive messages about our employees’ heroic efforts, customer and patient success stories, and words of support, thanks and encouragement. We share these stories inside the Company and postings that we call Hillrom Strong, as they acknowledge the power of teamwork, and our role to help while bringing our mission to life.

So, thanks. And now, let’s turn over the call to Q&A.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session of Hillrom’s Q2 earnings call. [Operator Instructions] I’d like to remind participants that this call is being recorded. And a digital replay will be available on Hillrom’s website for seven days at www.hillrom.com. The first participant — our first question comes from Larry Keusch of Raymond James. Your question, please?

Larry Keusch

Thanks. Good morning, everyone. Obviously, John, a lot of demonstration of what you guys are doing to continue to execute during the pandemic. I guess just some questions. As you think about the remainder of the year, and I recognize that you’ve suspended your guidance. But, how are you thinking about just ramping up procedures at this point, kind of what’s the view right now relative to how preparedness, either by hospitals or governments may shake out here? Again, just some high level thoughts as you kind of think about the dynamics around the remainder of the year?

John Groetelaars

Yes. Thanks, Larry. First, let me start with our vision and our strategy. I feel really good about the vision we outlined of advancing connected care and the criticality of that in the prior pre-COVID environment, the current COVID environment and even the post-COVID environment. That strategy and our main strategic priorities really hold intact throughout this period of time, and in fact, if anything, have been reinforced.

So, I mean — and I think we’re in this, as I tried to communicate in our prepared comments, we are in a really enviable position that we can stay the course without radical contemplation of significant shifts in resources and capital deployment to both, invest internally and continue to look for external inorganic opportunities.

So, let me start with that comment first as a backdrop, specifically around the recovery. I think, we’re pretty much in line with what you’re hearing around our peer group and our providers. We’ve listened very closely to what our providers are saying. I’ve had a lot of interactions with major provider networks and individual hospital CEOs and CFOs. And I think, there’s a growing consensus that we start to see elective procedures come back at the back half of the current quarter, and as we enter our fiscal fourth quarter, it continues to accelerate. Does it in our fiscal fourth quarter ever get back to the kind of pre-COVID volumes? That’s a crystal ball that no one has to really determine what that return to baseline activity looks like and when it comes back. So, our comments around the shape and speed of recovery and what the health care demand effectively ends up looking like, over the next six months, is really hard to predict. And even, the transition between our third quarter and our fourth quarter is really hard to predict in some of our areas. And those are some of the main reasons we suspended our guidance.

Even though we’re halfway through our own fiscal year, just the timing of what the outcomes will look like in Q3 versus Q4 is a very complex equation with not — a lot of new variables that we’ve never seen before.

So, in general, we think things do start to recover from here as states begin to open up and as the understanding of the financial implications to health care providers, both in the hot zone of an impacted COVID area, and equally important, those who are not heavily impacted. One would argue that those health care providers and those systems that kind of shut down activity and then did not have a wave of COVID patients arrive, they’re suffering pretty significantly financially as well.

I think, the other thing I would comment, just a bit of a macro comment, Larry, and that’s really around the point of the stimulus money that’s been provided and approved from Congress. The actual flow of those funds is only starting to begin to show up.

And so, the amount of funds that any individual provider receives is still an unknown. They’ve received some small portion of the total amount allotted to them, but they haven’t received — nor do they have visibility to what that ultimately looks like for them. So, we have a short period of uncertainty where providers don’t understand their current P&L and their own balance sheet. That should get resolved in the next couple of months, along with the resumption of normal activity around surgical, ambulatory care and diagnostic care.

So, once those two things come together, I think the environment for our customer, our biggest customer group of acute care centers, will be much better understood. And I think, we’ll be able to then provide better clarity on what that — what the implication of that is to the CapEx environment.

Larry Keusch

Okay. Very good. I guess, just one other one here, and maybe just a super fast one for Barb. But, again, you sort of got into this a little bit on your prepared comments that one might think that the buying right now of beds would represent a pull forward of demand. And you might find yourself in an air pocket. But, I think you’re sort of suggesting, that may not be the case. So, again, maybe if you could expand on what you’re seeing out there and why do you think this may not just be a pull forward situation? And then, just quickly for Barb. I think, if I have this right, I know that you’re now looking for $40 million of non-core revenues in this fiscal year. I thought it was previously closer to $25 million. So, if I am right on that, could you just please help us understand what changed? Thanks.

John Groetelaars

Yes. I’ll take the first part, Larry, and then pass over the non-core revenue piece to Barb. I think, if you look at slide 25 in our presentation, I think that really gives you a nice depiction of the resilient part of our portfolio, the 60% of which — as I stated in my prepared comments, 40% of that 60% is experiencing high demand, I mean, significantly high demand, as we stated in our comments, both in beds, vital signs monitoring, thermometry, respiratory care, all of those are seeing a significant increase in demand.

On the bed portion, we tried to and did provide commentary of how much we think of that as pull-forward. Roughly half of it or more than half of it, we think is just increased demand for additional capacity. And we saw many areas around the U.S. and around Canada and Europe, where suddenly there was an increased demand for expansion capacity. And it was — clearly not pull forward of our pipeline, at least our near-term pipeline that we have visible to us, and we’re actively working. So, roughly, a little more than 50% was expanded demand in the bed category, and the remainder was pulled forward from future periods, more in the near term.

So, that said, I mean, I think we’re obviously looking at a very robust Q3. We have good visibility to it, we have a significant, record orders and backlog of smart beds coming into the quarter, and continuing orders and backlog building in some of these other critical products like monitors and respiratory products. So, those continue to give us near-term visibility that we’re going to have a very strong Q3.

What happens and how we transition, I think you laid it out well, which is we’re going to have a transition. None of us want this to be sustained, for the sake of humanity, that we have this ongoing rush for expanded capacity. So, there will be a transition.

What I like — what I love about our portfolio is that we’re really well positioned to adapt. And I think we’ve proven we can be quick and agile to adapt to the new environment as it transitions. And our portfolio being as broad and diverse as it is, will allow us to transition when that time comes, transition away from some of these critical care products into the portfolio products that are driving value for health care and represent some nice growth opportunities for us in the future along the lines of respiratory health and remote patient monitoring.

And, I’ll turn it over to Barb for the comment around the — or the question around the noncore revenue.

Barbara Bodem

Hi, Larry. Thanks for the question. You’re absolutely right. Previously, we had been estimating that the noncore revenue from our international OEM surgical business was going to be $25 million. We’ve actually seen some increased demand from them this quarter. And so, we are working to meet that. And therefore, we’re not estimating that it’s going to be closer to $40 million. It does not change our trajectory about exiting this business, nor does it change our goal of sort of retiring the core, noncore calculations for next year.

Operator

Rick Wise of Stifel.

Rick Wise

Let me start off with Care Comm. I mean, obviously, it sounds like it was impacted, and understandably hospitals are focusing elsewhere. Maybe you could help us appreciate in a little more detail exactly what’s happening, and how you expect this critical part of your business and strategy, how expect the Care Comm story to unfold over the next six months or get restarted? And maybe just as part of that, John, given the significant smart bed demand, could you just spend a minute on helping us understand how that possibly — I don’t know if I’m thinking about it correctly, but possibly potentially accelerate your connectivity initiatives as we recover, if I’m thinking about it correctly.

John Groetelaars

Yes. So, Care Comm did deliver double-digit growth for us in the second quarter and including double digit growth for Voalte. So, we came into the quarter feeling good, even as the initial phase of COVID was hitting, we still ended up with a double-digit growth product category for us. However, as we ended the quarter, we saw customers completely focus on preparedness around COVID. And the patients that were about to be coming indoors, so — and restricting access, of course, which makes complete sense.

We’re still in that phase of taking care of these patients and restricting access to our teams who would need to be there to be on site to install and complete the verification and validation of the communication systems and be able to recognize revenue. So, we expect that will occur again along the trajectory that we try to outline around the next two quarters. And as we get into our fourth quarter, our fiscal fourth quarter, our access greatly improves and we can — in a majority of sites we can get back in there and complete the work and begin to get revenue recognition going.

In the interim period, one of the five products we launched was around Voalte Extend, which was deployed in several applications to allow a cloud-based solution for off-premises use in a field hospital situation specifically. And that was met with strong response.

We also partnered with AgileMD, which is really an AI — small AI company with some great technology to help really develop best practices around pathways and clinical pathways and early warning detection for patients, who are deteriorating, specifically around COVID-19, which I think was a good early deployment of the strategy we talked about many times around our digital products offering and how do you take the connectivity of monitoring patients to the next level, so you can provide insight and intelligence. And we’re happy to be doing that with this partner in the current environment.

As it relates to the second part of your question around the longer term strategy, I think, you’re absolutely right, Rick, that this does validate the importance of clinical communication, workflow, communicating with patients who are potentially in isolation, monitoring their vital signs very closely in real time, and being able to respond and adapt to a changing condition for patients. Some of these solutions can easily be adapted to help preserve PPE, and manage patients, as I mentioned, in isolation, preventing ICU visits.

So, we think that is strategically very well aligned. And the recent acquisition we did with Excel Medical is another good example, right? You have live waveforms on a smartphone, you’re able to monitor patient status and see and interact with the patient vitals without to be in the room. So, we are — again, it reinforces our strategy and gives us confidence that we’re on the right path here, as we think about a post COVID world.

Rick Wise

Great. And maybe just on the financial side. You obviously had excellent record gross margin. It seems like you are long-term on a path to moving them higher because the portfolio, the mix, new products, et cetera. But just — I know it’s tough to give guidance now and I’m not expecting anything precise. But, just as we think about the next couple of quarters, are you sustainable at this level because of the strength in the portfolio we’re seeing, or no, the mix is actually going to be a headwind for the next quarter? How should we think about it? And as long as you’re — I’m doing financial, I’ll sneak in — maybe you can talk about capital deployment and M&A. What are your priorities now?

Barbara Bodem

Hi. Rick, it’s Barb. Hey. First, talking about gross margins. We have seen really healthy gross margin expansion in the first half of the year. When we think about Q2 in particular, we saw 180 basis points, 140 of that coming from portfolio mix. But, it’s important to remember that of that portfolio mix, about half of that contribution is coming from the divestiture of the surgical consumable business last year, as well as contributions from our acquisitions. And as we anniversary those dates, you’re not going to see that same lift that you get in the first part of the year from those actions. So, that is going to wane as you think about the back end of the year.

Now, as you think about the mix of the portfolio, as John outlined earlier, we do think that there’s about 40% of our portfolio that’s going to see some challenges in the remainder of the year. In that bucket are some of our lower margin products. So, overall, we think product mix in the latter part of the year will still be a positive for us. But, there will be many puts and takes in there as we look at demand changes and think about what the underlying cost structures are.

So, I would just encourage you to think about the anniversarying of our M&A activities and how that will reflect in the gross margin over the course of the year, but also take into consideration, we do think we’ll see positive contribution from portfolio mix, just from the changes we’re seeing in demand in the second half of the year.

With regards to capital deployment, John used the phrase earlier about staying the course. And I would say that that is exactly the same when we think about capital deployment. Balance sheet is really strong. Cash position is good. Access to capital is good as well. And so, when we think about our priorities, as we’ve talked about before, first and foremost, we’re going to be looking for ongoing growth opportunities. So, M&A will remain a priority for us, looking for the right M&A with the right financial and strategic criteria. We will continue to maintain our dividend. We just recently increased it. That’s the 10th year in a row that we’ve increased our dividend. That’s not something that we see changing at all.

And then, with regards to other areas, stock repurchases, we have traditionally used repurchases as just a way of managing our dilution over the course of the year. And in fact, at the beginning of Q2 before COVID really started to be felt in the markets here, we completed this year’s repurchase to offset dilution for 2020.

And then, finally, if we don’t have great investment options to go after in front of us, we’re going to use whatever cash we have to continue to pay down debt and build up our coffers for when we do see the right opportunities. So, really, staying the course here, the priorities really haven’t changed as we think about capital deployment.

Rick Wise

Thank you.

Operator

David Lewis of Morgan Stanley is online with the question. Please state the question.

David Lewis

Good morning. And thank you for all you’re doing for patients and hospitals, John and team. I want to go out a little bit more, John. I know, you’ve got some questions here in the next six months. I mean, it’s very clear from your presentation that the next quarter is going to see significant demand in the business. I don’t think investors are very focused on the next six months. There are kind of two debates out there, John. If you think over the next 12 to 18 months, one debate is, they’re going to see some level of pandemic preparedness that’s going to be sustained; and the other is that this is just an acute demand dynamic and the capital environment is going to get challenging. So, my kind of questions there related are, what are hospital CEOs and procurement officers saying about how prepared they were and how prepared they have to be in the future? And then, on the other side of the equation, how do you think this crisis compares to the 2008 financial crisis from a capital perspective? And then, I have one quick follow-up for Barb.

John Groetelaars

Yes. I think, it’s early innings, right? We’re still in the middle of the crisis, dealing with these illnesses coming in the door, and at the same time, planning on getting back into some level of normalcy on elective and urgent procedures.

The early indications would be — and I wouldn’t want to extrapolate too far off of this, but there’s a tremendous amount of input from providers, both here in the U.S. and internationally that we were not prepared and we don’t have enough capacity. Whether that was our intense discussions on ventilators that we were directly involved in or the panic that people had in their eyes and in their urgency around getting new ICU beds and med-surg beds into their environment, not to mention monitoring equipment and the like. So, post this pandemic and post the analysis of how well we were prepared here in the U.S. and how well various countries in Europe and around the world have been prepared, I think, we’ll see some — I would be surprised if we don’t see some large scale changes around what our surg capacity is and how we deal with it. We clearly — as bad as this has been, it could have been a lot worse. And we were not in the state of preparedness that we should be. So, there’s likely a longer-term opportunity here for market expansion, too early to say.

And then, I guess, as it relates to the CapEx environment, we went through this before. We’ve been through multiple cycles and we did a retrospective review recently and we looked at it again in the last couple of weeks. During a very uncertain and — uncertain time around Obamacare and a liquidity crisis around the financial crisis, during that time, which is different than this, and I would argue worse in some ways as it relates to CapEx. During that time, we saw a double-digit decline in what is now 10% of our portfolio. So, that would represent about a 1% headwind in the future, as we get past — into the time frame you’re talking about of 12 to 18 months. So, if that scenario develops, I think that’s a reasonable headwind to consider. I don’t think we would change our view on that.

What’s unknown in the near-term is really this transitional period. When we come off of this strong Q3, what does Q4 look like, what does Q1 look like? It will be what it will be. I think, we are extremely well-positioned to adapt and adjust and move our emphasis and our portfolio with the times and with the changing needs in the health care environment. And I do think that our strong value propositions around Care Comm, around remote patient monitoring, in the acute care setting and integrating that with Care Comm platform, driving our respiratory care business for home ventilation as well as acute ventilation that we’re seeing now from this pandemic. But, also, as we pivoted on our several of our new product introductions, I would highlight that one of the ones in there deserves a special attention, which is adding remote monitoring to our — one of our vital signs monitoring devices for temperature, blood pressure and SpO2. This will be a device that next month we’re going to launch. And it will allow us to have multi-parameter vital signs monitoring in an ambulatory or home setting that is directly connected through an app and a website to allow clinicians to monitor patients without seeing them, without needing to be at their bedside, without having them to come in the office, ideal for COVID patients but also for remote patient monitoring and telehealth. So, I think that represents yet another accelerated growth vector for the Company as we look forward.

David Lewis

That’s very, very helpful over the next 12 months. Thank you for that. Very detailed. And then, Barb, just a quick one for you. I think, the volatility of the device environment is giving us kind of a new definition of what incremental and decremental margins are for many of our businesses. I guess, I was struck by some of your comments here. Other supply companies are seeing significant upside to numbers, but significant spending associated with that upside. Can you just give us a sense of how you’re thinking about incremental and decremental margins during this process? And specifically, with some of these increased demand forecast and increased capacity dynamics, what type of manufacturing spending and what type of logistical spending you’re having to do to support these customers and what that means kind of from a margin perspective here over the intermediate term?

Barbara Bodem

No worries, David. Nice to hear from you. As we think about what we’re doing to expand our capacity, we’ve talked about how we’ve done some additional hiring. We have done some minor reprioritization in our CapEx spending to make sure that we’re putting the right equipment in there as well. But, in general, the only real headwind that we’ve seen with regards to overall cost has been related to freight and transportation. And we were experiencing some of that already into Q2, and yet we still posted that 40 basis points of productivity improvement. And so, we feel like we’ve got a good handle on the incremental costs that are coming our way as a result of the stress in the supply chain. But, they’re not material. And we’re more than able to offset that with the ongoing initiatives that we have in our manufacturing organization.

John Groetelaars

Yes. And the only other point I might make there, David, is as we’ve seen our outlook being as confident as is — we are looking, and of course, we’re saving money on less travel and less meetings and so on. We’re going to redeploy that money into investments internally where we can get more out of our new product launches and come out the back — the other side of this pandemic really in a state of preparedness and readiness to adjust and adapt. So, those organic investments are going on and are activated as we speak.

David Lewis

Thank you so much.

Operator

Bob Hopkins of Bank of America is on line with the question. Please state your question.

Bob Hopkins

Hi. Thanks and good morning. Thanks for all the detail. I wanted to follow-up on some of the questions that have already been asked, one on beds and capital and the other on Care Communications. And I guess, the way I’d ask the question on the outlook for beds and capital, I realize there’s a lot of uncertainty here about the near and intermediate term. But, John, you highlighted at least the potential for what you call the multiyear demand cycle. And I’m just curious from where you sit today, kind of how would you characterize the potential for that to actually happen? Is that sort of low conviction level at this point, high conviction level at this point? Just wondering from what you’re seeing today, how much conviction you might have, if that’s a possibility.

John Groetelaars

Bob, as we’ve all looked at various pandemic models and learned more acutely what epidemiologists do on a day-to-day basis. I think we’ve — it’s become — in this particular case, this become highlighted to me and to our team here in the area of ICU capacity, in particular, whether it’s certain spots in our country, in the United States, or significant increases in demand that we’ve seen internationally, and I’ll point out recently Canada, as an example. And they came in with a flurry of orders across the country. And Italy was another one where their action really spoke volumes around from a relative point of view, how they recognize they are woefully short of ICU capacity to deal with these kinds of pandemics or outbreaks.

So, I actually think it’s more potentially more international, where it’s really clear that ICU capacity is not at the level it should be. And probably some regions that have been hard hit, namely New York, New Jersey, who have came very close. And without the additional field hospitals that were put in place, they could have been in a really difficult situation, even worse than it was. So, it’s so early to say. But, I do think the postmortem on this or the post action review of this activity is likely going to recommend something in that area. I’d be surprised if it didn’t — that’s speculative. So, what’s my conviction level? Less than 50-50. All that said, less than 50-50. We have — unfortunately, humans have a short memory. So, once this is passed, I don’t know if we’re going to really take on the lessons and change our behavior. But, I think it’s warranted in this area that we have better capacity.

Bob Hopkins

Very fair answer. And then, on Care Communications, I heard you answer to Rick’s question, and there’s a potential for this on the other side of this pandemic for that business to potentially accelerate, I guess, because the need for it seems so acute. That’s a decent-sized business for you now. I’m just wondering, given all that you know today, just thinking about the long-term outlook for that business. And I know, it’s connected to the whole Company, but independently, roughly around pre-pandemic, around $300 million, what do you think the growth outlook — a durable growth outlook is for that Care Communications business? Is it double digits? Is it 20% plus? Just kind of a rough thought on what you think the durable growth outlook is for Care Communications on the other side of the pandemic, understanding that today you’re limited in terms of your ability to install inside a hospital.

John Groetelaars

Yes, great question. I can tell you what it was in our prior outlook. We did have a view to double-digit growth there over that three-year period. That’s under a re-visitation as we kind of get through this remaining part of the year and think about our guidance for next year. But, strategically speaking, the growth outlook, the need and the innovation that’s going to take place in that area does not change my view. It is — reinforces the importance and the direction we were taking and I think puts us in a really good position to have acquired some of the best assets out there, added to it with the recent acquisition of Excel Medical. And quite frankly, some of the opportunities for innovation there as we exhibited with our partnership with AgileMD, we can rapidly partner and expand in that digital product offering very quickly and adapt very quickly. So, I’m excited about it. And we’re excited about the prospects of adding even more value to clinical communications in the acute care setting, integrating it with smart beds and smart monitoring of beds, and making sure that vision comes to life in a meaningful big way, but also taking it off premises and looking at ways to do that in the non-acute care setting in the future. So, I think strategically, great business. We’re going to continue to invest there. And we really like our positioning.

Mary Kay Ladone

Jack, we have time for two more questions this morning.

Operator

Certainly. Kristen Stewart of Barclays is on the line with a question. Please state your question.

Kristen Stewart

Hey. Good morning, everyone. Just a couple of questions for me. Just first on just this slide 25. It’s very helpful. Just want to get a sense for kind of the 60%. I think, you’ve done a good job of kind of quantifying some of the downside of the 40% of the reduced demand. I guess, I’m just trying to understand what the upside level is. The 60%, they said resilient demand, but it seems like that’s more significant upside, particularly in the third quarter. It seems like you’re having a harder time kind of quantifying what that fourth quarter looked like. But, any way you can kind of help us just sort of size maybe your backlog of business? I know, you’ve got that $20 million contract coming in from HHS, but any other way to just kind of size the rest of the backlog in terms of dollars or anything in that? And then, I just have one follow-up.

John Groetelaars

Yes. Thanks, Kristen. We tried to do that in the slide here in our prepared comments with orders on the bed side of things being 70% above our Q1 level, and having orders 2x our normal level in beds in total. So, those are probably the best indicators we can provide you at this point.

As we come into April, our view hasn’t changed. That continues to look solid. What might — what we — some of this activity, whether it’s on the capital side around beds or the surgical side, it’s very easy, whether it’s here or internationally for a project or a delivery to ship in Q4 versus Q3 or vice versa. So, the timing around Q3, Q4, there is hard to predict and one of the primary reasons that we decided to withdraw our guidance just because of that — the timing element and the shape and slope of that recovery, where we can get back in and complete the work around Care Comm and surgical installations that were scheduled. So, I wish I could give you more. I just don’t have the clarity of the crystal ball between Q3 and Q4.

Kristen Stewart

And it wouldn’t be correct to say, the 40% of the business is kind of looking down, 40% of your revenues are down more than 20%, and then the 60% is up x percent or…

John Groetelaars

Yes. I guess, what I would do is, if you take that 60% and then put it into 20% being pretty stable, flat to low single digits. So, now, you have this remaining 40% that’s the offsetting ballast to the 40% declining. Right? So, the 40% increasing is increasing at a much higher rate than the 40% declining. Right? I mean, that’s where we’re seeing significant — we took action to double production in many of those product areas. It takes time to ramp up to that level and then replenish your inventory, so you can’t directly correlate. Doubling production means doubling revenue, because of the timing element and a supply chain element that doesn’t get factored in. But, it gives you a sense of — it’s a high-double-digit growth area for us, and it’s a strong tailwind.

Barbara Bodem

I would just add, Kristen, that as you think about those magnitudes, then it becomes all about time, and it becomes about the sustainability of both of those elements, right, both the upside and the downside. And that’s where it gets really tricky is how well those are going to match up to one another.

Kristen Stewart

Right.

John Groetelaars

Yes. And, I think — and the one — yes, I sorry, Kristen…

Kristen Stewart

No, no, no. Go ahead.

John Groetelaars

The one thing I wanted to just clarify is that with the surge in smart beds, a lot of those, again, are fully featured beds, right, with connectivity, with sensors. We saw a lot of them requesting early sense deployments in there. So, we think that’s positioned us really well compared to our peers and our competitors out there because like we’ve always said, when you’re making these capital purchases, even in the middle of a pandemic, you’re going to want a future proof what you’re buying because. This is a long lived asset. You want to make sure you’re going to get the most out of it. And I think, we’ve been well-positioned to add future features to this increased demand surge.

Kristen Stewart

Right. And those all have recurring type of revenues associated, like you said watch sense and all those?

John Groetelaars

Yes. That’s right.

Kristen Stewart

Yes. Okay. And I think, Barb, you had made the comment on don’t extrapolate out kind of this quarter, but it kind of sounds like, if I’m hearing you right, on those numbers that it sounds like you’re kind of thinking that net-net, these numbers look like your future quarters may, again, depending upon the timing and what not, it sounds like you’re thinking things still seem positive going forward on the balance, maybe 3Q, just with timing with this event order probably coming in and just the timing of maybe some of these bed deliveries maybe a bit stronger and then we’ll kind of see how the quarters kind of shake out, I guess, directionally, not guidance.

Barbara Bodem

Yes. I think that there are certain things that you can feel good about in terms of gross margin expansion. You can feel certainly clear that we’re expecting peak demand in Q3. But just where we don’t want you to extrapolate or where we all need to be cautious, because there’s too much that’s unknown, is really about this timing. And it’s the timing between Q3 and Q4, and it’s the timing of how long you sustain the high demand versus how long it takes us to recover and to see the improvement in that 40% that is being challenged. So, I would just — we’re not giving guidance for the year for a reason because that timing is really difficult to estimate.

John Groetelaars

Now, just for the sake of clarity, I don’t think we’ve said this, but we do expect Q3 to be a stronger quarter than Q2. Right? I mean, that — it seems like what you’re kind of getting at there, Kristen, and I think we can say that with a high degree of confidence that Q3 will be better than Q2.

Kristen Stewart

Okay.

John Groetelaars

What the shape of that looks like? How big it is versus Q4? That’s the part we just don’t have good visibility on.

Kristen Stewart

Perfect. Thank you so much. And thanks for all you guys are doing on the front line.

John Groetelaars

Thank you.

Mary Kay Ladone

Great. Jack. And we’ll close with just one more question.

Operator

Certainly. Matt Taylor of UBS is on the line with a question. Please ask your question.

Matt Taylor

Good morning. Thank you for taking my question. So, I just wanted to ask you because it is kind of a microcosm of this bigger question that other folks were referring to what happened in Canada. Could you talk about the size of the orders there, how much that contributed, and maybe what it represents versus what you normally see there? I just wanted to get a sense for the kind of expansion that you’re seeing in one market?

John Groetelaars

Yes, Matt. It’s — I don’t think we have specific numbers here, but it’s — Mary Kay is looking. But, the overall demand we saw — and some part of that got delivered in Q2, and part is going to get delivered in our fiscal Q3. We’re also seeing that in Europe playing out. We didn’t talk about Europe today on the discussion. In our prior call, we said there were project delays, and EMEA was going to have a stronger Q3 than Q2, and that still remains our perspective. And part of that now is going to be reinforced with the demand signal and the demand we’ve seen in our critical care products that we outlined earlier. So, we’ll see a nice contribution from international on a go-forward basis as they implement. Some of these expansions in Canada was one of the one — as an example of a market close to home where new demand was clearly came through. We didn’t anticipate this kind of level of ICU demand coming from Canada. It wasn’t in our funnel. And almost province by province, we saw increasing demand for expanded capacity as they were moving quickly to get to be prepared for the coronavirus.

Matt Taylor

Okay. And then, as a follow-up, you mentioned you have this $20 million order for the non-invasive ventilators for HHS. And I guess, I was wondering, are those products earmarked for a stockpile? And have you had any conversations with the federal government, with state governments or international ones about any of your products that could be used in future stockpile?

John Groetelaars

Yes. Good question. This $20 million will go to one destination, HHS. And, I think, it will either go in their stockpile or FEMA will distribute it, I think they’re working through with that what that scenario is. We also had several states make some purchases of the same product. We, of course, want to follow the usage of that product and support it and see that it gets deployed in the right setting to avoid additional ICU stays or help wean patients off of mechanical ventilation, which will be the ideal use. And there’s clearly also a use case to provide it in the home and potentially avoid a hospitalization, if you can provide it like you with oxygen just that next level of support, because you’d have oxygen plus ventilation support in a non-acute care setting, which for COVID patients could be a real benefit. But, we haven’t — we don’t have the use case yet developed there, but we’re actively looking at trying to do that.

Matt Taylor

Got it. Thanks a lot, John.

John Groetelaars

Great. Thank you, Matt.

Well, thanks everybody for the call today. And I appreciate all your questions and interest. And we look forward to our next update and the interim meetings we might have.

Operator

Ladies and gentlemen, this concludes today’s conference call with Hill-Rom Holdings Incorporated. Thank you for joining.





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