Hardwoods Distribution Inc

TSX:HDI

Earnings Call Transcript 2019-Q1

[Operator]

Good morning. My name is Jessica, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hardwoods Distribution Inc. First Quarter Results Conference Call. [Operator Instructions] Mr. Rob Brown, you may begin your conference.

[Robert J. Brown, President, CEO & Director]

Thanks, Jessica. Good morning. Welcome, everybody. Thanks for joining us this morning. I'm going to start with a brief overview of our first quarter, Faiz Karmally, our CFO, will follow with a more detailed financial review. Then I'll return to discuss our outlook going forward. As we anticipated, it was a challenging start to the year as the company was impacted by headwinds, this included severe weather, which contributed to lost sales days in a number of our regions and some uneven market sentiment affecting U.S. construction markets. As a result, our first quarter 2019 profit and EBITDA results reflect these challenges and didn't keep pace with results from a year ago. However, I'm very pleased with what we did accomplish, particularly in light of the challenges. We delivered a 6% increase in sales, a 4.4% increase in gross profit as compared to the first quarter of 2018. We also increased cash flow from operations by a significant $29 million year-over-year. We did this by carefully managing our balance sheet and lowering our investment in noncash working capital, and we retrieved our gross profit percentage at the higher end of our forecast range. At the same time, we delivered on all of our capital allocation priorities. We reduced our bank debt by $4.6 million. We executed on our acquisitions pipeline. Using $4.8 million of the cash we generated in the first quarter, we purchased Far West Plywood and distribution business located in the attractive Southern California market with annual sales of approximately $16 million. This represents our eighth successful acquisition of the past 8 years. We also continued to return value to our shareholders. We announced a quarterly dividend of $0.08 per share. This is our 26th consecutive quarterly dividend. We also put our share repurchase plan into action. As of April 30, 2019, we've now repurchased over 94,000 of our shares for approximately $1.2 million. So overall, it was a challenging but also a very productive first quarter. I'll return later to speak about our outlook and focus going forward, but first, I'll pass the call over to Faiz, to review our financial results. Faiz?

[Faiz H. Karmally, VP, CFO & Secretary]

Thank you, Rob, and good morning, everyone. I'm going to provide a general overview of our results for the first quarter of 2019, and then I'll provide some comments on our financial position and our capital allocation plans. Starting with the first quarter consolidated revenue, our sales increased 6% to $287.1 million, that's a gain of $16.3 million compared to Q1 2018, and it breaks down as follows: acquisitions accounted for $7.4 million of the year-over-year increase or 2.7%; and we realized the translation gain of $12 million related to the positive foreign exchange impact of the stronger U.S. dollar. This was partially offset by a $3 million or 1.1% decrease in organic sales related to the first quarter challenges that Rob discussed. Gross profit grew by 4.4% in the first quarter to $51 million. That's a year-over-year improvement of $2.2 million, and it was driven by the higher sales partially offset by a gross profit margin percentage of 17.8% as compared to 18% last year. Operating expenses were up $4.6 million year-over-year to $41.2 million. This reflects a combination of factors including the impact of a stronger U.S. dollar on translation of U.S. operating expenses, investments in support of our strategy, added expenses related to acquired businesses and a $0.5 million increase in bad debt expense. We generated first quarter adjusted EBITDA of $17.3 million, which was down $1.6 million year-over-year. This was mostly due to the higher operating expenses partially offset by the $2.2 million increase in gross profit. Our income tax expense decreased by $0.9 million year-over-year, reflecting lower taxable income, and we generated adjusted profit of $6.5 million or adjusted diluted profit per share of $0.30, which compares to $8.6 million or 40% in the same period last year. Higher expenses and a $0.6 million increase in net finance expense were the key factors in the year-over-year change in adjusted profit partially offset by higher gross profit and a decrease in income tax expense. Now, looking at our financial position and capital allocation priorities. Our balance sheet continues to be responsibly managed. As at year-end, our net bank debt-to-adjusted EBITDA after rent ratio was a conservative 2x, and our net bank debt-to-capital ratio was just 28%. We also had $85.8 million of unused debt capacity available. Going forward, our capital allocation priorities are to continue to focus on supporting future growth and ensuring continued responsible management of our balance sheet, executing on our acquisition pipeline and continuing to return value to shareholders in the form of dividends and share repurchases. Now, I'll turn the call back to Rob. Rob?

[Robert J. Brown, President, CEO & Director]

Thanks very much, Faiz. I'll close today with a few comments on our outlook. We anticipate sales growth and gross margin percentage improvement to come later in the year. While we've seen some recent weakness in U.S. housing demand, we view this as a temporary pause, not a directional change. The current level of U.S. housing and the inventory remains below the long-term average. This paired with the favorable demographic characteristics of U.S. consumers, we believe offers good support for housing demand over the long term, and we continue to execute on our corporate strategies, including specific product market share and profit optimization initiatives that will enable us to take advantage of the anticipated long-term market demand. In the near term, our focus will remain on responsible management of the balance sheet and meeting our capital allocation priorities, including executing on our robust acquisitions pipeline and continuing to return value to shareholders in the form of dividends and share repurchases. The combination of our long-term corporate strategies and near-term focus are integral to the pursuit of our 5-year growth target of achieving $1.5 billion in sales and increasing profitability by continuing to optimize our platform, leverage our size and strength to enhance our competitive advantage. With that, I thank you for your attention, I'll now turn the call back to the operator to provide instructions for the Q&A period. Jessica?

[Operator]

[Operator Instructions] Your first question comes from Hamir Patel of CIBC Capital Markets.

[Hamir Patel]

Rob, what's -- I just wondered if you could maybe clarify what level of organic growth you're targeting for the remainder of the year? And I think in the last conference, you're pointing to low to mid-single digits, just wondering if that's changed?

[Robert J. Brown, President, CEO & Director]

Yes. We're taking a little bit more of a general approach here, Hamir, not put out a specific figure. I think we need to see how the balance of Q2 unfolds. As you know, we had a bit of a pause from a housing sentiment perspective in Q1, I think we need to see how that plays out a little bit more. So we've been fairly deliberate in terms of choosing the language that we did choose, which is to say, we do expect to return to growth and large improvement as well later in the year, but we're not kind of putting a pin in it yet as to timing and quantum.

[Hamir Patel]

Okay. So -- but it is -- does that imply maybe Q2 year-over-year sales would be down? Is that the implication there?

[Robert J. Brown, President, CEO & Director]

I think we're taking a little bit of a wait and see because we're just into Q2 now. So -- but not implying one way or the other but to say, Q2 is a transition or step period between Q1, which was slower and -- but back half of the year where we do expect things to be picking up.

[Hamir Patel]

Okay. Fair enough. And I -- Rob, I've never seen hardwood -- the Soft Wood Plywood imports from China, which I assume a bulk of that has been that Pine Face product that you've spoken about in the past, that those imports look like they're kind of heading to 0 now, so has that had a positive impact on actual product pricing yet?

[Robert J. Brown, President, CEO & Director]

We're getting there. So, yes, because that product is now being considered to be putting stroke of the trade case, while that consideration process goes through the normal channel, you really don't want to be handling that product because there's the possibility of retroactive duty. So the impact of that has been what you said, I think it's largely dried up new imports. There's still some of that product kicking around in the market but it's starting -- which it's significantly dissipated, which for us, to finish the answer, would be a positive if we won other kind of alternative products that's out in the marketplace and that's helpful for what we're trying to build with our own proprietary supply line from Asia.

[Operator]

Your next question comes from Yuri Lynk of Canaccord.

[Yuri Lynk]

Rob, just want to kind of square your outlook. Sounds a little more cautious in the near term but I thought the first quarter came in perhaps a little better than you were expecting. I think on the last call you were calling for a kind of flattish year-on-year Q1 sales and you did 6%, so what am I missing there?

[Robert J. Brown, President, CEO & Director]

Yes. So as we peel down on the 6%, there's a little bit of foreign exchange in there, then there's acquisitions growth. So our perspective of first quarter on sales, we came in organically just a little bit under a 1% decrease, so that's kind of the footing that we're starting with. As we're looking forward into the year, I would agree with you on -- it actually turned out little bit better in some respects under the category of margin, where we indicated we will be in the 17% to 18% range, and we ended up at the higher end of that 17% to 18%.

[Yuri Lynk]

Okay. And then what gives you the confidence to expect a pickup in activity in Q2 -- sorry, in H2?

[Robert J. Brown, President, CEO & Director]

Yes. Good question. So you and I, we'll probably be reading all the same macro things and if you look at what building products' participants are out there saying, there's general positivity over the balance of the year. But we balance that from a micro perspective, which is talking to all our operators in our 62 locations and what are they seeing in terms of customer activity and attitude from our 35,000 customers, and the general sentiment is very good for later in the year. Customers are optimistic and see forward-looking business as very positive. So that's kind of underpinning our perspective on second half as well.

[Yuri Lynk]

Okay. And then, are there any forward-looking internal KPIs that you could share with us? Or that you're looking at that would also support that order books or indicative orders or anything like that?

[Robert J. Brown, President, CEO & Director]

No. So we don't typically have highly visible forward order file going forward. We've got, obviously, program and recurring business but people aren't generally booking out orders with us that go out weeks or months. It's more of a weekly fulfillment model in terms of servicing our customer base. So nothing I can specifically hang my hat on in that regard other than as we've seen in conversations we've had with our customers as they plan their businesses for the rest of the year.

[Yuri Lynk]

That's what I thought. Okay. That's fair.

[Operator]

Your next question comes from Maggie MacDougall of Cormark.

[Maggie Anne MacDougall, Director of of Institutional Equity Research]

I was wondering if you could give us all a bit of an update on the Kitchen Cabinet trade case that you've talked about in the past. And then, if there are any other changes or developments on the trade front that you're currently keeping an eye on.

[Robert J. Brown, President, CEO & Director]

Sure. So to start with the Kitchen Cabinet case, that was launched fairly recently and just for summary for the group on the call, we do view that as a positive development in the sense that, that's a case brought by U.S.-based Kitchen Cabinet manufacturers to impose tariffs on ready-to-assemble cabinetry coming from China. So the idea here being if tariffs are imposed there and some of that production is moved back to North America, that would benefit -- directly benefit our customer base, which is small to mid-sized cabinet manufacturers. Where that's at in the process, is the case has been accepted by the Department of Commerce and it's been affirmed to go forward by the ITC as well, so it's now on a very defined time line. We will know by the end of May, what preliminary anti-dumping duties will be. And then there's sequence of steps that outlines through the balance of the year. Basically, by -- in the fourth quarter, we will know what duties will be, both countervailing duties and anti-dumping duties, and we will have a sense of whether the case is going to be affirmed. So it's really around about end of October, we'll have a fuller picture on that, Maggie. And -- sorry, just -- I was just going to finish the thought in terms of your follow-up question. In terms of other duties in -- I think there's some meetings going on in the U.S. today, between U.S. and China. The whole chewing and throwing around Section 301 duties and going from 10% to 25%, et cetera, largely not applicable to what we're doing. The disruption surrounding trade between the U.S. and China, we've taken those lumps already with the trade case against Hardwood Plywood, which transpired in the course of 2017 and 2018. So what you're seeing in the papers today directly related to our product categories is largely noise, and we don't have to anticipate anything material out of that.

[Maggie Anne MacDougall, Director of of Institutional Equity Research]

Okay. Great. Switching gears, I wanted to discuss the big drawdown on the inventory and working capital, which really boosted your cash flow this quarter. So hoping you could provide some color on, first, what has changed since the end of the year to prompt you to take your inventory down by such a good degree? And then, secondly, if you now feel you're positioned properly with regards to working capital or if you think there is additional drawdown on working capital that could be achieved later this year.

[Robert J. Brown, President, CEO & Director]

Sure. So the way to think about our working capital is typically December 31 and the Q4 is our low point for the year because there's less sales activity, so receivables are lower, and we typically bring inventories down to seasonal low at that point as well. And then you would normally expect that to build through Q1 and Q2, and then again in Q4, we start to dissipate. So the Q1 that we reported here yet, it is against the grain to the pattern I just described but it's consistent with what we indicated in our fourth quarter, which is that we had been heavy on inventory, and we ended the year with more inventory than we would typically carry relative to sales pace. The reason we were heavy was really the disruption of our buying patterns in 2018 around implementation of the trade case in the U.S. against hardwood plywood from China. We carried more inventory, more safety stock than was necessary, and we also brought in a number of new products to trial to replace the hole that was left by China -- Chinese plywood being shut out of the market. So it was a deliberate effort, and we basically released some of the excess that we were carrying in Q1.As to your second question, what does it mean for the balance of the year? I would say, there's actually still some more excess to release, we've made very good progress in Q1 but we're not fully where we want to be. So the way to think about it is as we move into Q2, we would typically be increasing our working capital, most certainly our sales if we get a seasonal lift in sales, but also we would be increasing our inventory. If we increase our inventory in Q2, it's likely to be less than normally would be the case because of an offset with the excess that we've been carrying.

[Operator]

Your next question comes from Nick Corcoran of Acumen Capital.

[Nick Corcoran, Equity Research Analyst]

I just want to touch on the gross margin percent of the high end of the range. I was just wondering, if this is sustainable through the remainder of the year and what factors might impact it, either up or down throughout the rest of the year as well?

[Robert J. Brown, President, CEO & Director]

Sure. So, yes, we are pleased with the progress on margin. There is a little bit of relief strength to emerge here in terms of some of our newly built import supply line coming on stream, Nick. But the other factor growing a little bit the other way was related to Maggie's question, we did reduce inventory in the first quarter, and as we reduce excess inventory, also, you'll often do that at a slightly reduced price, which can compress your margin. So on balance we've got a little bit of both of those things going on, that probably continues as we move through the second quarter here. The other thing that's helpful, it was mentioned earlier in the call it's just the -- some of the other products that were in the market, the Hardwood Plywood market, the Pine Plywood product and also not mentioned yet today, transhipped product from other participants in the market. Those are starting to dry out and that was helpful for us in terms of being able to reestablish the stronger margin that we are used to.

[Nick Corcoran, Equity Research Analyst]

Perfect. That's great color. And then switching gears, I just want to -- there's talk about the uneven market segment that you're talking about, and can you comment on any internal strength or weakness in the quarter and maybe how we should think about things through the remainder of the year just in terms of overall activity in different areas? And how that might affect your sales?

[Robert J. Brown, President, CEO & Director]

Yes. So -- I mean, the uneven market sentiment really happened in Q4 where we saw some chewing and throwing in the stock market and there was some choppy indicators around housing and a little bit of concern there. You saw broadly across building products, participants that continued into Q1. But what changed is the Feds' stance in the U.S. was helpful. In Q4, we were staring at 2 -- likely 2 interest rate hikes through 2019, and now we're into a different footing, which is probably none. No action from the Fed and in fact, we've seen 30-year mortgage rates decline, they're in the low 4s, which is an exceptional place for consumer. So we see that sentiment kind of improving and then, although we can't quantify it per se, it's also, as I mentioned earlier in the call, just positive sentiment now coming out of our own customer base in terms of the activity levels there, just to think of the balance of the year.These comments are primarily related to the United States because that's where 90% of our business is. I'll make a quick comment on Canada. We did see efforts -- governmental efforts to kind of cool the housing sector in Canada, whether it's stress tests on variable-rate mortgages at the federal level or home buyers' taxes in -- foreign buyers' taxes, sorry, in some jurisdictions. I think some of those things really did work. We saw, generally, a softer housing market, although noting we saw yesterday, a big number out of CMHC for April starts in Canada. So I think some of the choppiness in the housing market in terms of different metrics that come out will -- even with something we've been dealing with and may continue to deal with. But we focus in, again, on the longer-term trends in terms of household formation, millennials who're going to want to live in old homes and the existing housing stock relative to what's been built in the last number of years, and we see that as a long-term trend that we'll take advantage of.

[Nick Corcoran, Equity Research Analyst]

That's great. And then the other end markets like commercial, could you just comment on that, what you might see next.

[Robert J. Brown, President, CEO & Director]

Yes. Commercial's been good. It's been pretty stable, and while it doesn't necessarily grow, the highs aren't as high and the lows aren't as low. We're continuing to see good activity there. And this is one area, actually, relative to Yuri's earlier question where we get a little bit of a -- more of a forward-looking insight because we spend time working with architects and designers in the commercial sector to get our products specified in building projects. And we're seeing some good successes there. And those are longer-term build-outs, but it bodes well for future pipeline in that sector.

[Operator]

Your next question comes from Maggie MacDougall of Cormark.

[Maggie Anne MacDougall, Director of of Institutional Equity Research]

Just a follow-up question. Was wondering if you could possibly quantify the impact on your sales growth in the quarter from the lost sales days because of poor weather.

[Robert J. Brown, President, CEO & Director]

Yes. Oh, darn, I thought someone was going to ask that. Faiz and I have wrestled with that and it's proven very difficult. To put a number that we feel has a lot of concrete to it, it would be very -- it's been very difficult to estimate. If you look at 60 -- plus or minus 62 sales days in a quarter, there's 19 to 22 in a month, how many days within that were impacted in how many regions and what proportion of your customers because some customers were simply closed and other customers were open. So apology, we just couldn't get there. What I would say is, if you look at the -- we don't often talk about weather. It's not a big impactor per se in our business in the way it might be on others. But if you look at the precipitation patterns, they were 50% higher than would be typical in many of our geographic locations. In East Coast, they're as much as 300% higher. So it was a real thing for Q1.

[Operator]

[Operator Instructions] There are no further questions at this time. Please proceed.

[Robert J. Brown, President, CEO & Director]

Okay. Thanks, Jessica, and thanks, everybody, for joining. Appreciate, as always, the interest and questions. Do reach out to Faiz or myself if you've got follow-ups, and appreciate you taking the time to listen in today. Thank you.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.