Hillman Solutions Corp

NASDAQ:HLMN

Earnings Call Transcript 2022-Q2

[Operator]

Good morning, and welcome to the Second Quarter 2022 Results Presentation for Hillman Solutions Corp. My name is Shannon, and I’ll be your conference call operator today.

Before we begin, I would like to remind our listeners that today’s presentation is being recorded and simultaneously webcast, the company’s earnings release presentation and 10Q were issued this morning. These documents and a replay of today’s presentation can be accessed on Hillman’s investor relations website at https://ir.hillmangroup.com.

I would now like to turn the call over to Michael Koehler with Hillman.

[Michael Koehler, VP, IR and Treasury]

Thank you, Shannon. Good morning, everyone. And thank you for joining us. I am Michael Koehler, Vice President of Investor Relations and Treasury. Joining me on today’s call are Doug Cahill, our Chairman, President, and Chief Executive Officer; and Rocky Kraft, our Chief Financial Officer.

We will begin today’s call with a business update and quarterly highlights from Doug followed by a financial review of the quarter and a guidance update from Rocky. Before we begin, I would like to remind our audience that certain statements made in today’s call may be considered forward looking and are subject to the safe harbor provisions of applicable securities laws. These forward-looking statements are not guarantees that future performance and are subject to certain risks, uncertainties, assumptions, and other factors. Many of which are beyond the company’s control and may cause actual results to differ materially from those projected in such statements. Some of the factors that could influence our results are contained in our periodic and annual reports, filed with the SCC.

For more information regarding these risks and uncertainties, please see slide 2 in our earning call slide presentation, which is available on our website, https://ir.hillmangroup.com. In addition on today’s call, we will refer to certain Non-GAAP financial measures. Information regarding our use of, and reconciliations of these measures to our GAAP results are available in our earnings call slide presentation. With that, it is my pleasure to turn the call over to our Chairman, President and CEO, Doug Cahill. Doug.

[Doug Cahill, Chairman, President, and CEO]

Thanks, Michael. Good morning, everyone. Today I’m going to provide an overview of our strong second quarter results, give an update on our position moving forward and discuss the current operating environment before I turn it to Rocky to talk numbers. Before we dive in, I’d like to give you a quick overview of Hillman and our differentiated service model, especially for those of you who are new to our story. We’re the largest provider of hardware products and solutions in our categories in North America.

Our unique approach to sourcing, distribution and service sets us apart from our competition. We win with our customers because we design source innovative products, and execute inventory and merchandising solutions for complex categories. Not only are these must-have high margin categories for our customers, but we help solve difficult problems with them like labor shortages and logistical challenges. We had a strong quarter driven by the hard working team in Hillman and our differentiated service model. Our 1,100 member sales and service team is an important part of our competitive moat and I’ll discuss it in a moment.

During the second quarter of 2022 we generated $62.3 million of adjusted EBITDA. Margins were healthy during the quarter. We benefited from having fully caught price at the end of March, resulting in 3 full months with the appropriate price cost mix. Net sales grew to $394 million. This 4.9% increase over the second quarter of 2021 was driven by the implementation of price increases over the past year despite lighter volume.

Now let’s dive into our how each of our business segments perform during the quarter. Hardware Solutions is our biggest business and makes up approximately 50% of our overall revenue. For the quarter, Hardware led the way with a 12% increase in revenue compared to the second quarter of 2021. Price increases were the main driver of the top line increase. Also contributing to the improvements were fill rates upwards of 97%, up from 90% a year ago.

This is why retail partners trust Hillman. 97% fill rate during one of the worst supply chains any of us can ever remember. Robotics and Digital Solutions or RDS makes up just shy of 20% of our overall revenue. During the quarter, lighter foot traffic coupled with a difficult comp quarter in 2021 resulted in a 2% decline in RDS revenue. Though this was on top of last year’s 57% increase in the second quarter.

In particular, engraving was soft as pet adoptions decline and unfortunately shelter populations are growing, which means there are less new pet owners than there were during ‘21 when it seemed to everyone was adopting a dog or cat. Our Canadian segment which makes up about 10% of our overall revenue performed very well during the quarter. Canada posted a 7% top line increase compared to the year ago quarter and ran their business very well driving strong bottom line results. Lastly, our Protective Solutions business makes up about 20% of our overall revenue. During the second quarter of 2022, Protective revenues were down about 12%, driven by retail softness including fewer promotional sales.

COVID related PPE sales contributed approximately $2 million of revenue for both periods and therefore, did not have a meaningful impact on the comparison. Now on a year-to-date basis, Protective sales were down 10%, but when backing out COVID related PPE sales, Protective is down less than 1% on a year-to-date basis. As we all know we’ve now seen 2 consecutive quarters of negative GDP growth and there are a lot of factors influencing the economy right now. Many aspects of our business make us resilient and position us well as we navigate these uncertain economic times. They include, number one, our heavy repair and remodel exposure; two, our competitive moat; three, our successful pricing initiative; and four, with lead time improvements out of Asia, we can lower inventories, while protecting our industry leading fill rates.

To start, it’s important to remember our business is focused on repair, remodel and maintenance. We’re not tight to new housing and we’ve grown our top line organically in 56 of the 57 year since our founding with an average top line organic growth of 6% annually since the year 2000. The only year that our top line didn’t grow was 2009, which is the bottom of the market during the great financial crisis. While our top line decrease by 5% in ‘09, our bottom line increase by 10%, which was the result of our cost coming down. During that crisis and other past inflations without fail, we’ve seen commodity prices softening, which we’re starting to see now.

Currently, you can’t read Wall Street without reading about the challenges companies have regarding labor, supply chain and inventory management. In today’s environment our competitive moat is more critical than ever and is helping solve these issues for our customer. This competitive moat consists of 3 components. Number one, over 80% of our 112,000 SKUs are delivered directly to the retail locations of our customers. We utilize our distribution network, which consist of 22 distribution centers to send their products to over 42 locations across North America for our customers.

In general, our customers do not have to worry about managing Hillman inventory in their distribution centers, supply chain logistics or shipping and labor cost. Number two, our sales and service team which consist of 1,100 associates provides world class service at their shelf for our retail customers. This team of warriors ensures that Hillman must have high margin products are in-stock, organized and optimized for our blue-chip customer base. Mick and Rick Hillman introduced this unique in-store service model over 27 years ago, which has allowed us to serve our 5 biggest customers on average for over 22 years each. And number three, 90% of our revenue comes from our brands that we own.

This is not only important to the consumer and the pro but allows us to differentiate our offerings based on specific retailer strategies. Additionally, we can implement customer feedback to improve our products to meet the evolving needs of our pro and DIY consumers. These 3 pillars are the back bone of our retailer partnerships. We allow our customers to overcome complex labor, supply chain and inventory challenges, while delivering industry leading fill rates in our categories. For example, many of our customers continue to struggle finding quality employees to stock shelves and managed aisles.

Our sales and service team do this for them so our customers don’t have to. Another example is managing inventory. Today, we’re seeing many retailers working to reduce inventory as their distribution centers are full of product. Some retailers have rented additional warehouse based to house in inventory and other categories and have been working around the clock to move products through their distribution networks. At Hillman, we ship over 80% of our products directly to the store, so our customers don’t have to worry about managing the inventory of our products.

And lastly, not having products on the shelf, we all know is the quickest way for our customers to lose revenue and market share. So in today’s economic environment, our moat has proven to be increasingly indispensable part of our relationship with our customers who know they can rely on Hillman to get products on their shelves even during the most challenging times. Let me give an example of how our moat can also drive new business by providing some detail of a recent new customer win. As we talked about briefly last quarter on the call, we won the fastener business at one of our major retail partners. The incumbent had a difficult time keeping products on the shelves, which gave us the opportunity to get our foot in the door.

After securing the new business, we shipped 150 truckloads with store-specific pallets for approximately 4,000 retail locations. This rollout has gone extremely well with fill rates of 99.7%, and we’re already receiving orders for more fasteners from this customer. Our customer is thrilled with how this rollout has gone and we believe this has the potential to drive additional business wins. I’ve run a bunch of businesses, and I’ve never seen one like this. We have a strong team, great customers and a bunch of hard-working folks at Hillman.

They ensure we win at the shelf and help nurture the long-standing partnership we have built with our customers over many years. Now turning to pricing and cost. As we talked about on our last earnings call, most U.S. companies, including us, negotiated new contract ocean container rates that became effective May 1, 2022. These rates were dramatically higher than last year and are expected to increase our cost by about $50 million on an annualized basis.

These increases hit all companies that import products from overseas, including all of our major customers. And so we have recently initiated yet another price increase to cover these additional costs. We expect our price increase to wholly offset these increased shipping costs in our P&L for ‘22 and beyond. Another quarter, another price increase. Let’s recap what we’ve done from a price cost perspective.

The latest price initiative marks our fourth increase since the beginning of 2021, and we expect to have taken approximately $225 million in price since then. Again, all of these have been dollar-for-dollar price increases to cover our costs. This breaks down to approximately $90 million of commodity costs, $15 million of labor and $120 million of transportation and shipping costs. Going into the past 24 months, our relationships with our customers were strong. And remarkably, even after these 4 price increases, our relationships with our customers, I think, are even stronger.

We believe this is because we have shown our customers that we’re only taking price to cover costs, not increasing our profits. We truly respect and are grateful for the healthy partnership we have with our customers. We remain in a strong position with them because of the mutual respect, our long-standing relationship in our competitive moat. In short, we bring something to our customers that our competitors do not. Thankfully, we do not foresee a need for additional price increases in the near future based on what we’re seeing today.

Now let me spend a minute talking about some specifics about our business. We’ve all read about retailers looking to reduce inventories while maintaining their in-stock levels, and we’ll work together with our customers to help them reach their goals. Because of our direct-to-store model, most of our customers don’t have inventory of our product in their distribution center. However, we may see some of our customers consider reducing inventories at the shelf by 2 or 3 weeks on slower turning items during the second half of this year. I can tell you with our direct ship network and the in-store Hillman team will make sure either way, our customers’ in-stocks continue to be high.

We’ll be reducing our own inventories as well as we think about lead times from Asia. We saw them peak during January of 2022 at 255 days. This means that when we place an order from our suppliers in Asia, it takes 255 days for that order to arrive in our distribution centers here in the States. Today, we’re seeing lead times around 160 days. In normal times, like 2018 or ‘19, lead times were approximately 130 days, so they’ve come down significantly since the end of January.

We believe that this dynamic will allow us to reduce our inventories by $50 million before the end of the year, while protecting our fill rates, which averaged 97% in the second quarter. Rocky will get into more detail on how inventory will impact our second half expectations shortly. As we discussed earlier, the majority of our product sales are driven by repair, remodel and maintenance projects. These are your pickup truck pros, your local contractors and DIYers. To be clear, we believe that our business is not reliant on new home construction.

For that reason, demand for our products has historically been steady through all economic cycles, considering our products are relatively inexpensive, particularly as it relates to the total cost of the project. We believe that the balance sheet of the U.S. homeowner remains healthy. While interest rates may slow new housing transactions, we believe the increase in home prices and therefore, homeowners’ equity over the past few years will be a meaningful driver of home improvement projects for years to come. We expect to see the continuing investment in the home as trends in nesting, aging in place and outdoor living remains prominent.

At the same time, we’re laser-focused on successfully negotiating this environment. We are also working on our growth initiatives, which include the expansion of quick tags machines, smart fob auto and our knife sharpening kiosk Resharp. We are also continuing to focus on new wins and share gains in categories like builders hardware, deck and drywall screws, anchors and what’s the last one -- Rocky? Barn door accessories. I know you’re waiting for them.

We strongly believe that we’re well situated for the second half of 2022 and into the future. I’m encouraged about the opportunities that lie ahead and the value we will continue to bring for all of our shareholders, customers and employees. With that, let me turn it over to Rocky.

[Rocky Kraft, CFO]

Thanks, Doug. This morning, I’m going to provide a quick summary of our second quarter results and then turn to our outlook and guidance for the remainder of 2022. Net sales in the second quarter of 2022 increased 4.9% to $394.1 million versus the prior year quarter. Hardware Solutions was the main contributor to the increase, which was up 12% to $225.4 million. Overall, the improvement was driven by a 16% price realization, partially offset by a 4% decline in volume.

As our retail partners have discussed publicly, April was a very light month in terms of foot traffic and volume. We saw May and June return towards the norm, but not enough to make up for April. Further, we saw softer volumes in July, which I will talk about in a few minutes. RDS sales decreased by 2% to $64.8 million. Lighter foot traffic, less activity in pet engraving and a difficult comparable quarter with the main drivers of the decline.

Our Canadian business had terrific performance in the quarter. Sales were up 7% compared to the prior year, and we significantly improved profitability for the second quarter in a row. Price, product mix and exiting unprofitable business have driven nice profit improvement in Canada. And while we don’t anticipate maintaining 17% EBITDA margins for the remainder of 2022 in Canada, we are well on our way to our minimum expected adjusted EBITDA goal of 10% across this business. Protective Solutions sales were down 12% or $7.5 million resulting from lighter volume and fewer promotional sales.

Looking at our year-to-date numbers for Protective, we are down only 1%, excluding COVID-related PPE sales. COVID-related sales for the quarter were $2.1 million compared to $1.6 million during Q2 of ‘21. However, for third and fourth quarters of 2021, COVID-related PPE sales were $15.1 million and $19.2 million, respectively, as we liquidated our COVID inventory. As a reminder, we worked with our retail partners to sell and donate these products in the second half of ‘21 at 0 or very little profit. We do not anticipate meaningful COVID sales for the remainder of 2022.

On a GAAP basis, net income for the second quarter of 2022 totaled $8.8 million or $0.04 per diluted share compared to a net loss of $3.4 million or $0.04 loss per diluted share in the prior year quarter. Adjusted earnings per diluted share for the second quarter of 2022 was $0.14 per share compared to $0.24 per diluted share in the prior year quarter. On an adjusted basis, second quarter gross profit margin improved by 50 basis points to 44.1% versus the prior year quarter. Sequentially, margins improved by 290 basis points. The improvements in both periods were the result of catching price costs in March fully benefiting the second quarter of 2022.

For the quarter, GAAP SG&A totaled $118.2 million compared to $111.7 million for the prior year quarter, driven by higher selling and warehouse and delivery expenses. Adjusted SG&A was $111.3 million compared to $100.2 million in the prior year quarter. This analysis backs out stock compensation, acquisition and integration expenses, certain legal fees and restructuring costs, which we feel give us a better analysis of our base expenses. Adjusted SG&A as a percentage of sales increased to 28.2% from 26.7%, driven by the higher SG&A. While our business has variable cost, the softness in quarterly sales resulted in adjusted SG&A as a percentage of sales coming in a bit on the higher side.

Subsequent to quarter end, we have implemented several cost-saving actions, including some reductions in headcount to better position the business for financial flexibility in the second half of the year. Adjusted EBITDA in the second quarter was $62.3 million compared to $64.5 million in the year ago quarter. Our results were driven by having caught price cost before the start of the quarter and a lift from strong earnings from Protective and our Canadian businesses. The decrease in EBITDA from the comparable quarter was anticipated and baked into our guidance and expectations. Now turning to our cash flow and balance sheet.

For the year-to-date in 2022, operating activities generated $14.7 million of cash as compared to operating activities using $59.8 million in the prior year quarter. The main driver for the improvement was that last year during the period of global supply chain shortages, we made the strategic decision to meaningfully invest in our inventory. This investment has allowed us to maintain our healthy fill rates, which we believe has helped us win new business. Capital expenditures were $28.9 million compared to $22.7 million in the prior year quarter. We continued to invest in our RDS kiosks and merchandising racks, which are important parts of our high-return CapEx initiatives.

Chip shortages continue to hinder our ability to produce robotic kiosks to meet demand, particularly our Resharp knife sharpening machines, which has kept our CapEx lower than we would like. Maintenance CapEx remained near 1% of sales as expected. We ended the second quarter of 2022 with $949 million of total net debt outstanding, up from $931 million at the end of 2021. At the end of the second quarter, we had approximately $118 million of liquidity, which consists of $100 million of available borrowings under our revolving credit facility and $18 million of cash and cash equivalents. Subsequent to the quarter end, we expanded our revolving credit facility by $125 million to $375 million and extended the maturity by a year.

This provides us with financial flexibility on attractive terms. We don’t have an immediate need for the increased line and importantly, we still expect to fully pay down our revolving credit facility by year-end. Our net debt to trailing 12-month adjusted EBITDA ratio at the end of the quarter was 4.7x, up from 4.5x at the end of 2021 and equal to where we were last quarter. Our leverage quarter end was expected given the normal operating cycle of our business. Our long-term target for net debt to adjusted EBITDA ratio remains unchanged at below 3x.

And by the end of 2022, we believe we conduce our leverage to just below 4x. Let me spend a few minutes talking about our short-term outlook. As Doug said, we were successful in securing our fourth price increase to cover the increase in contracted ocean container rates. The price increase offset an increase in cost on a dollar-for-dollar basis just like the previous 3. The price increase will be implemented throughout the third quarter.

As we look forward to the back half of the year, we will be fully caught up on price costs as we were in Q2. Additionally, we typically see an increase in sales and EBITDA during the second and third quarters as we talked about last quarter. Warmer weather during the spring and summer typically result in more trips to the hardware store driven by an increase in home repair, remodel and maintenance products -- projects. As we think about our guidance for the remainder of the year, there are two important aspects to consider. Number one is the consumer.

As we all know, there is some uncertainty in the economy right now and the consumer is being impacted by inflation. After gas and groceries, homeowners may be waiting to start that home improvement project they were previously planning to do. Number two is inventory. As Doug mentioned, we will likely see some of our customers reducing their inventory levels, which translate into less order volume than we would see typically. As lead times have come down and commodity costs are starting to soften, we believe we can reduce our own inventory by approximately $50 million between now and the end of the year.

With that, it will be important to balance the long-term relationships we have with our suppliers to ensure they remain viable partners into the future. That said, so long as sales at our customers are generally healthy and the consumer isn’t greatly impacted by a potential economic slowdown, we believe our full year ‘22 results will fall within our original guidance range given back in March. While we have benefited from taking price, sales volumes were soft during April and have again been soft in July. With this visibility, we are providing the following updates. We now anticipate our full year 2022 net sales will come in towards the low end of our original guidance, which was $1.5 billion to $1.6 billion.

This implies that our second half net sales will see a percentage increase in the mid-single digit range versus the second half of 2021. We also anticipate our full year 2022 adjusted EBITDA will come in at the low end of our original guidance, which was $207 million to $227 million. This implies that our second half adjusted EBITDA will see a percentage increase in the high single-digit range versus the second half of ‘21. Our guide also implies that adjusted gross margins during the second half will remain fairly consistent with what we saw during the second quarter of ‘22. Lastly, we still feel comfortable that our original free cash flow guidance range of $120 million to $130 million is intact.

As we look a bit further out, our long-term growth algorithm of 6% organic net sales and 10% organic adjusted EBITDA growth remains intact. On the other side of the current macroeconomic environment, we have a high level of confidence that our business will see adjusted EBITDA growth in excess of our algorithm. We believe this as we are beginning to see commodities, containers, freight and other costs begin to moderate in the second half of 2022, which should benefit us in ‘23 and beyond. While our approach to implement dollar-for-dollar price increases has resulted in some margin rate degradation, we have not given price back dollar for dollar when inflation moderates historically. This gives us potential margin expansion over time, which we believe we will begin to see flow through our P&L in ‘23.

Our business continues to have several structural tailwinds that Doug discussed earlier. We expect these trends will continue and position Hillman to capitalize on sustained growth in the home repair, remodel and maintenance market. As we look forward, we continue to believe that our competitive moat will allow us to win new business, drive sales and allow us to perform at or above our stated growth algorithm over the long term. With that, Doug, back to you.

[Doug Cahill, Chairman, President, and CEO]

Thanks, Rocky. Our competitive moat has more than proven itself in today’s environment and now serves as an even more appealing solution for our customers. The Hillman model with our 1,100 field sales and service folks combined with our direct-to-store delivery brings solutions to our customers’ complex needs, especially in today’s challenging environment. The value we bring our customers is reflected by our customers’ willingness to accept our pricing actions, grants additional shelf space and award us new business, all 3 of which we’ve seen in the first half of this year. While the current environment is uncertain, we’ll stay focused on controlling the controllables and taking great care of our customers.

As we look forward, we remain confident in our moat, and we believe we can drive long-term growth and build meaningful value for all of our shareholders. With that, we’ll begin the Q&A portion of the call. Shannon, can you open the call up for questions?

[Operator]

[Operator Instructions] Our first question comes from Reuben Garner with Benchmark.

[Reuben Garner, Benchmark]

So Doug, I missed the $50 million and I think was the number in incremental inflation. Can you talk about what that was and the timing of the price increase that you’re implement -- timing and amount of the pricing increase that you’re implementing to offset it?

[Rocky Kraft, CFO]

Yes. Reuben, it’s Rocky. So that $50 million was all related to contracted container rates. And so we spent a lot of time talking about that on our first quarter call. Basically, the world renegotiates contracted container rates on May 1 of each year.

And so beginning on May 1, we saw our contracted container rates quite frankly, go up dramatically as did the entire industry. And that will end up flowing through our P&L starting in late Q3, but hits us more in the fourth quarter. And then as we just said, the price increase to offset that is going in place kind of as we speak and will come in throughout the third quarter. So the timing of when we begin filling the cost and when we get -- begin filling the price benefit are at about the same time. And again, that $50 million, just to be clear, is an annualized full year number, not what the impact in ‘22 will be.

[Reuben Garner, Benchmark]

Okay. Got it. So this is the one from May. This is not incremental since then. So the -- I guess, since May, I think it’s been pretty clear, at least the spot rates for container freights have been falling.

I think material cost pressure should be declining. Can you kind of tell us where we -- where those items stand today and what kind of benefit they could bring in 2023 at these levels? Just trying to see how much further we need to see the freight rates fall and the steel prices fall for it to be, I guess, for you to fully get back the price cost headwinds that you dealt with over the last 1.5 years?

[Doug Cahill, Chairman, President, and CEO]

Yes. I think Reuben, we have seen as our customers have things like lumber. Last year, they peaked at 1,400 and dropped to 500. This year, they peaked at $1,200 per 1,000 board foot they’re at 527. We’ve seen China steel come down.

The last 3 weeks, it perked up a little bit. It was slightly up. But China steel has softened a bit. We have not seen Taiwan steel, which we buy and most of the world buys most of the deck and drive drywall screws, that steel price -- those steel prices haven’t come down, but they had plenty of demand, and they also had some -- but traditionally, if you go back in history, Taiwan steel prices will follow China steel prices over time. On the ocean container, all of us were shocked even our customers when the container folks jacked the rates and almost doubled them for contract May 1.

What we were seeing at that time was spot prices for a 40-foot equivalent around $15,000 to $17,000. Contract prices had gone up to close to $9,000 on, again, a 40-foot equivalent. We do mostly 20s. But since then, spot prices have dropped and that’s putting pressure on the contract pricing and you would think these guys would have to flinch at some point because as people -- I mean if we can take 150 -- if we have $150 million more inventory because of lead times and they’re changing, you can only imagine, Reuben, what’s going to happen when all the big retailers can do the same kind of thing and take inventory out of things that they directly import from overseas. So we kind of see the commodity bubble starting to come down.

Now as you know, it takes 5 months to come through our inventory. You also know it takes right now 160 days to get it but we like the trends where they’re beginning, and we’ll just have to see how it goes. So far, so good there. And I think us and our customers are both excited that it’s been 15 months of craziness.

[Reuben Garner, Benchmark]

Okay. And then a clarification on the inventory side. So you’re kind of -- you had to go to the low end of the range for EBITDA, but it sounds like the free cash flow is reiterated. That $50 million reduction, is that more than you anticipated in the guidance previously? And then it sounds like, Doug, if you’ve got $150 million excess that means there’s another $100 million to go in -- potentially in ‘23 if we see more normalization in the supply chain?

[Rocky Kraft, CFO]

Yes, everything you said is correct, Reuben. So we -- the -- our original guide had a working capital benefit of, call it, $20 million to $30 million. We think we’re going to do better than that and we’ll be able to offset the pressure that is inside the guide around EBITDA plus. We’ll pay about $7 million in cash interest more this year than we originally anticipated because of raising -- rising rates.

[Operator]

Our next question comes from Lee Jagoda with CJS.

[Lee Jagoda, CJS]

Just, I guess, starting with just foot traffic at retail. Can you talk to the foot traffic trends that you saw during the quarter at your retail partners and how that translated into volumes, particularly in fastening and hardware in Q2? And then maybe talk to how that follow through in July and the first few days of August?

[Doug Cahill, Chairman, President, and CEO]

Yes. I think, Lee, if you -- April was just a horrible month for everybody and the coldest, wettest in 20 years. So that really scared our retail partners, particularly because of their seasonal business put a lot of pressure when you’ve got 4 months to sell something and you basically lose a month. So we’re impacted by footsteps, people swing by and pick things up. They see things, they cut a key, whatever.

And so we saw that and had -- as we reported a tough April. We saw May and June about where we thought. And I think our retailers made up a bit of the seasonal miss that they had. And then July kind of the same thing as April, it was just kind of a whole hummer foot traffic was down. But there’s a couple of things -- there’s one other thing going on, Lee, that I’m sure you know, the last quarter of our retail partners second quarter, the last month is July, and they’ve got work to do on their inventory levels and every merchant has a goal.

So I think the -- you did see traffic down a bit, and you also saw retailers trying to do everything they can to control their inventories. And I’m sure you’ve read that in some of their reports. So I think that was the combo there. But again, we could see August and September be very similar to May and June. We just don’t know.

And we’re not going to swing dramatically, but we do see some impact when footsteps are slower.

[Lee Jagoda, CJS]

Got it. And then just one more for me. I know you had mentioned customer reductions on the inventory side, just on the slower-moving SKUs. If I look at the revenue guide, can you quantify the impact in the second half that you expect to see from those slower moving SKUs just being reduced at retail?

[Doug Cahill, Chairman, President, and CEO]

Yes. And Lee, that’s a hard one. We don’t know because, again, we’re fortunate that we don’t have a bunch of drills and sales and distribution centers. Our stuff goes direct to store, but I’ll give you an example. If they have 25 weeks in total on our product, they could do 2 or 3 weeks. And with our direct store and our people in the store, their fill rates would be okay. Now they would go back to 25 weeks if they went down to 23 when things normalize because we see it right now, for example, Lee, with lumber coming down, deck screws and drywall screws, you’re starting to see particularly deck screws jump. So they -- retail -- my experience is retailers traditionally go ditch to ditch on this. They take inventories down then they, Oh my God, it’s taken off again. But that’s the kind of swing you would see.

And that’s part of the reason that you see our range on EBITDA and sales to the lower end. We’re just trying to be prudent with the things that we think are going to happen. And we understand our retailers have cash flow objectives they want to make. We’ll do our part. We’re not a big part of that. But that’s part of why we took the range to the lower end.

[Operator]

Our next question comes from Brian Butler with Stifel.

[Brian Butler, Stifel]

First one, just on the headwind from 2Q into -- on EBITDA from 2021 second quarter to about 140 basis points. Can you give some color around the puts and takes? I mean, obviously, inflation was a big chunk of that, but if you could break down maybe how the items offset for that 140 basis points of headwind.

[Rocky Kraft, CFO]

Yes. I think the 2 biggest areas that we saw a headwind were in hardware and RDS, Brian. And so we talked about in RDS. It was a really tough compare when you think about coming out of COVID and the number of adoptions of dogs and cats and our engraving business performed really well. And quite frankly, this year, comparatively did not perform well on a unit basis.

As Doug said in his prepared remarks, the kennels and the places where they keep animals, now the shelters are full. And it’s unfortunate, but that does impact our engraving business. And as you know, it’s a very profitable business for us. When you think about hardware, while we were able to catch price/cost, that softness in the period, which, quite frankly, we didn’t fully expect. We aren’t able to leverage as quickly in that business -- it’s not like you can delever the business fully over the course of a month.

And so we have taken some actions as we think about the back half, as I talked about in my prepared remarks. But in the quarter, we actually performed a little better than we expected in HS from a rate perspective on the gross margin line, but SG&A aid a lot of that up because we were expecting to ship more product.

[Brian Butler, Stifel]

Okay. That’s helpful. And when you think about that, I guess, the prices and the cost kind of offsetting each other as you roll into 2023. What is kind of the -- I mean it’s a 0 margin pass-through. So what is the kind of headwind just from those -- the price increases and the cost that you’ve seen as it rolls through 2023? I mean there’s -- what is that -- is there a way to quantify that 0 margin headwind on margins?

[Rocky Kraft, CFO]

Yes. So Brian, we’ve said publicly that we believe that it would be about a 300 basis point headwind. We would tell you, in the second quarter, we actually did a little better than that in the hardware business, probably closer to 200 basis points of headwind from the dollar-for-dollar pass-through. That’s one of the reasons that, as we’ve said, we expect margin rate to kind of remain constant through the rest of the year is we performed a little better than we expected in the second quarter from a rate perspective and hardware, and we think we’ll hold on to that as we hold on to price cost for the rest of the year.

[Brian Butler, Stifel]

Okay, great. And on the cash flow side, going from a negative $14 million in the first half to the guidance of the $120 million to $130 million, can you kind of break that down into some buckets on where that comes from in the second half?

[Rocky Kraft, CFO]

Yes. I mean the simplest way to think about it is we’re a user of working capital typically in the first half of the year. And in the second half of this year because lead times have come down. Not only will we seasonably be a -- will working capital be a benefit, but we’ll also have the benefit of those reduced lead times. And so the big driver is that change in working capital plus the profitability that we’ll have in the back half of the year.

[Brian Butler, Stifel]

Okay, great. And last one for me. Just any more color on the chip shortage and kind of your thoughts on how that plays into 2023 or what you’re hearing on that easing up?

[Doug Cahill, Chairman, President, and CEO]

Yes. It’s -- we have enough to be 1,000 machines end of the year. We’ve got 200 more chips I heard last night. One of the crazy things, Brian, is the Molex connectors, which is basic wiring connectors that we use on all of our machines. They’re tight now because the auto guys have absolutely bought every single one of them.

So it’s just silly stuff that you’d say over time is not going to be a problem. I believe after the first quarter of ‘23, we’re not going to have any problem on chips. But until then, we’re just still kind of nursing our way. But the Molex connector as an example, is just your basic wiring connector. And all of a sudden, the auto guys, I think they bought everyone on eBay plus everyone in stock and silly stuff like that. Doesn’t cost very much, kind of a basic thing. But we’re still kind of hand to mouth. And so a little better, but not open gates. I just -- I’m not overly concerned about it in ‘23, though.

[Operator]

Our next question comes from Ryan Merkel with William Blair.

[Ryan Merkel, William Blair]

My first question is on the EBITDA outlook for the second half. Can you just clarify what changed? Is it just the retail foot traffic and the destock? Or is there something else?

[Rocky Kraft, CFO]

Ryan, it’s all volume.

[Ryan Merkel, William Blair]

Okay. Got it. And then should we think about the destock impact in 3Q more than 4Q? Or how do we think about those quarters.

[Doug Cahill, Chairman, President, and CEO]

I think so. I mean that’s a good question, Ryan. I think the current -- I mean, kind of when you saw those guys in Arkansas come out with the early release, everybody knew that inventory was going to be a problem. Target was one of the early canaries. And just think about it. I mean, they import so much stuff from Asia they had the rent extra distribution centers to hold more inventory because of the lead times. And with lead times coming down, I mean, Ryan, one of the interesting things going on right now is we’ve all seen situations where retailers needed to reduce inventories because of the business pressure. But I don’t think we’ve seen a combination of that and lead times going from 250 call it, days to 160 in such a short period of time. So what we’re doing in that regard is really balancing, making sure that our long-term supplier partners don’t get in trouble because there could be some suppliers on the other end of some other categories that just get whipsawed so bad, and we’ve got long-term 20-plus-year relationships. So I think it’s probably a second half deal.

We -- I think some of that was going on in July, and we’re just fortunate that we don’t have a bunch of products sitting in distribution centers that our retailers can take out when you go direct stores, just not that much they can do. So I would say for the most part, it would be third quarter.

[Ryan Merkel, William Blair]

Okay. That makes sense. And then a longer-term question here. As we think about 2023, what is the potential range of benefit to EBITDA with container rates down and raw down? I know it’s a moving target, but is there anything you can provide?

[Doug Cahill, Chairman, President, and CEO]

There really isn’t. I mean, we’re playing with the numbers, too. Think about this. It’s really directionally, things are coming down. But if you just think about the math, if we don’t buy $50 million and we take inventories down, that’s a good thing. But by the time we do buy more and float it and get it through our inventory, you’re really talking about midyear ‘23 and it doesn’t mean that we won’t have benefit before that because there should be. But for the most part, if you just think about the math, when you take your inventories down and it takes, call it, 150, 60 days to get it and takes 4 or 5 months to get through your inventory. It should be pretty interesting in the second half of ‘23. We’ll feel things get a little better here and there until then, but that’s the kind of timing of it.

[Ryan Merkel, William Blair]

Yes, I hear you. So I said, well, I’ll put it in my words, 43% plus gross margin is still in the car, you probably start to see more of that second half ‘23, the impact starting to help you?

[Rocky Kraft, CFO]

That’s right. That’s a good way to think about it.

[Ryan Merkel, William Blair]

Okay. All right. Last one for me. So the macro could be rough in ‘23, depending on who you listen to. I think in 2009, sales were down 5%, EBITDA was up 10%. Could that be the same sort of range of outcomes in ‘23? Or has anything changed?

[Doug Cahill, Chairman, President, and CEO]

Yes. I think the only thing that’s changed there, Ryan, I’ve gone back and spent some time with Nick and Rick Hillman who were running it at the time. We had a little bit higher percent local hardware business as a percent of our total then, as we do now, even though it’s a big part of our business, and they do extremely well in that kind of environment have historically. So I would say the 5 that Mick and Rick saw, maybe 8, 9, something like that because the mix is a little different. But directionally, I think it’s pretty similar and then commodities are bigger now than they certainly were in ‘09 as far as the run up. So, it should be better on that side as well. So it’s probably a little more on the sales side, but I think under $10 and then likely better on the EBITDA side, if you think about the math.

[Operator]

Our next question comes from Matthew Bouley with Barclays.

[Elizabeth Langan, Barclays]

You have Elizabeth on for Matt today. I was just wondering, you’ve been able to successfully implement various price increases in the past, and we’ve seen that benefit in your margin this quarter. But as the macro unfolds, do you expect that there will be any risk to implementation of that price increase into Q3? And do you think people will push back on that at all?

[Doug Cahill, Chairman, President, and CEO]

So right now, we feel very good about the fact, Elizabeth that we have it done. Let’s be honest, retailers are very smart people. They’re looking at cost as well. They know that we’re going to be fair with them. And will there be pushback over time? Absolutely, there should be because that’s them doing their job. But as we’ve said, we’ve only gone dollar for dollar, and we’ve hurt our margin percentage, and we’ll get that back. And then we’ll see some benefits on the other side. But we’ll work with our retail partners to make sure. I mean, it’s our job when you have the share we have to make sure they’re competitive.

We’re going to do that, and we’re going to be fair, and I know they will as well. So this fourth increase, we’ve been successful. We’re just getting everything implemented now. And then our retail partners have been great, but they’re not happy with all this inflation nor are we, and we’ll work together on the other side, but that will be a good side to be on.

[Elizabeth Langan, Barclays]

Okay. And also, it would be helpful if you could talk a little bit about what you’re seeing in R&R like particularly, if there are any differences between what you’re seeing in DIY versus Pro.

[Doug Cahill, Chairman, President, and CEO]

It’s interesting the Pro continues to have backlog. But I -- in the Pros that we’ve talked to, we got about 1,000 in our network that we kind of ping and just kind of stay in touch with and give them product and get feedback. They’re not -- they’re still -- they still have a nice book of work in front of them. But their answering calls and trying to book days. So I think they see it out there 6 months from now, it’s not going to be like it’s been.

So number one, they still are strong, but they’re worried as everybody is with what’s going on with the consumer on gas and groceries and the inflation pressures. The other thing -- it’s interesting, Elizabeth, when we look at things, when lumber jumps to $1,200 or $1,400, we really see that with our retail partners on projects and deck screw sales and some of the connectors we sell. And then when it drops as it has to $527 right now from $1,200, it takes back off. So there are things like that, that influence demand. But for the most part, our stuff is pretty boring and kind of chugs along, and we like that.

[Operator]

This concludes the Q&A portion of today’s call. I would like to turn the call back over to Mr. Cahill for closing comments.

[Doug Cahill, Chairman, President, and CEO]

Thank you, everyone, for joining us. We look forward to updating you as we move through the second half of this year. And again, I appreciate you joining us today. Thank you.