Hardwoods Distribution Inc

TSX:HDI

Earnings Call Transcript 2021-Q1

[Operator]

Good morning, ladies and gentlemen, and welcome to the HDI Q1 2021 Results Conference Call. [Operator Instructions] This call is being recorded on May 13, 2021. I would now like to turn the conference over to Rob Brown, President and CEO. Please go ahead.

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

Thanks, Joanna. Good morning. Welcome, everyone. Thanks for joining us. I'm going to begin this morning with a quick overview of some of the financial and operating highlights for the quarter. Faiz Karmally, our CFO, will follow with a more detailed financial review. Then I'll return to discuss our outlook going forward. Before we begin, a reminder that, as previously announced, we're reporting our results in U.S. dollars, effective January 1, 2021, given approximately 90% of our revenues come from the U.S., this is considered an appropriate currency for reporting purposes. Note that comparative numbers have been recast to conform with this presentation.In 2020, HDI achieved record-setting financial performance, and we've continued this trend into 2021. I'm pleased to report that Q1 2021 represents the best quarterly results in the company's history with record top and bottom line performance. As we anticipated, robust construction market conditions created strong demand across our product groups, lifting both sales volumes and product selling prices. Our results also benefited from strong execution on the strategic and operating fronts, including our acquisition strategy, which added $23 million to our Q1 sales.On a consolidated basis, our sales were up over 20% year-over-year to a record $291.2 million on roughly equal measures of organic and acquisitions-based growth. We paired the excellent sales with our best-ever gross margin percentage at 19.9%. This was above our historical range. We further enhanced our bottom line results with a tight focus on operating expenses. Our organic operating expenses were flat this quarter as compared to the same quarter in the prior year as we continue to closely manage costs across the organization. The result was a record bottom line, including an 85% increase in profit per share and a 52% increase in adjusted EBITDA. It was an outstanding quarter for HDI, and I want to talk briefly about some of the factors that are enabling us to make the most of the strong macro demand environment we're experiencing across the U.S. and Canada.First, in a period of rising demand and tightening supply, HDI is well positioned to continue meeting customers' product needs. Our size and close working relationship with vendors makes us a preferred partner to our suppliers. This is particularly important when product supply conditions are constrained as we're seeing in the market today. Our extensive global supply chain and branded import program gives us an added advantage, providing additional product alternatives and volume availability to our customers. And our financial strength ensures we can invest in working capital and maintain the inventory we need. As North America's largest distributor of architectural building products, we have meaningful supply advantages compared to many of our smaller regional competitors. Secondly, our business model enables us to carry top line growth through to our bottom line. Our price pass-through model keeps selling prices closely aligned with product prices, which is especially critical when demand-supply imbalances increase product pricing as we've seen in recent months. This boosts our profits and EBITDA, which, in turn, converts very efficiently to operating cash flow. Overall, we're not just capitalizing on the opportunities presented by robust market conditions, we're building on them. And our strategies are contributing to improved profitability, record-setting results and our ability to generate strong shareholder returns. At this point, I'll ask Faiz to review our financial results with you in more detail. 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 2021, and then I'll provide some comments on our financial position and capital allocation plans. Note that all figures are in U.S. dollars, unless otherwise stated. Starting with the first quarter, consolidated revenues, we generated sales of $291.2 million, that was 20.4% or $49.4 million higher than a year ago, and it breaks down as follows. Organic sales growth added $24.2 million or 10% to our consolidated sales. Acquisitions added another $22.9 million or 9.5%. And an additional $2.3 million of sales gain was driven by the positive foreign exchange impact of a stronger Canadian dollar on translation of Canadian sales to U.S. dollars for reporting purposes.In our U.S. operations, sales increased $37.9 million or 17.7% year-over-year, reflecting both organic sales growth and the positive impact of acquired businesses. And in Canada, sales were up a significant CAD 12.5 million or 34.1% year-over-year, reflecting higher product prices and increased demand. Turning to gross profit. This grew to $57.9 million in the first quarter, an increase of 24.4% or $11.3 million from the same period last year. This improvement reflects the increase in our gross profit margin percentage to a record 19.9% from 19.3% last year, primarily reflecting an increase in the selling prices of our products without a corresponding increase in costs. Operating expenses for the first quarter were $3.5 million higher at $38.9 million, with acquired businesses accounting for most of this increase. I do want to highlight that as a percentage of operating expenses were lower at 13.4% as compared to 14.6% in the same period last year. This is a good indicator of our operating leverage and reflects our success in continuing to tightly manage expenses across our business.As Rob noted, we grew adjusted EBITDA by 52% year-over-year, setting a new record of $25.8 million. This strong result was driven by our higher gross profit, partially offset by operating expenses related to the acquired businesses. Profit grew a substantial 86% year-over-year to a record $13 million for the quarter, while adjusted diluted profit per share climbed to $0.64 from $0.33, an increase of 94%.Looking now at our financial position and capital allocation priorities. We ended the first quarter in a very strong financial position with a responsible balance sheet, strong cash-generating capabilities and significant liquidity. We have no term debt and maintained revolver facilities with springing covenants secured against high-quality working capital. At the end of the first quarter, our net debt-to-adjusted EBITDA after rents ratio was just 1.4x, and our net debt-to-capital ratio was 26%. We also had $75 million of liquidity available in the form of cash on hand and unused debt capacity. We remain confident in our ability to support our business strategies and continue creating value for shareholders.On that note, our capital allocation priorities going forward will continue to include executing on our acquisitions pipeline, supporting organic growth and returning value to shareholders in the 4-month dividends while remaining opportunistic as it relates to share repurchases. Now I'll turn the call back over to Rob.

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

That's great. Thanks, Faiz. I'll close today with a few comments on our outlook and our strategies going forward. Starting with market conditions. Indicators for the U.S. residential construction and repair and remodel markets remain highly favorable. Housing permits and housing starts are up sharply, driven by low mortgage rates, favorable demographic trends and a lack of housing supply caused by years of reduced building activity. COVID-19 pandemic has further accelerated housing demand, with more people working from home and many households seeking more living space. At the same time, North Americans are spending more of their time and disposable income on fixing up their homes, which is contributing to a robust repair and renovation market.All this sets the stage for continued demand for our products, and our customers today are the busiest they've been since the onset of the pandemic. The demand outlook for U.S. commercial markets is more mixed, which is not unusual for this large and diverse market. For us, commercial encompasses construction activity in health care, education infrastructure, public buildings, hospitality, office space, retail facilities and recreational vehicles. Some of these end markets are performing better than others, but the diverse nature of our own participation reduces the impact of dynamics in any one geography or end market.Forecasts call for commercial construction spending as a whole to grow in 2021 compared to 2020. With an overall strong growth environment forecast for 2021, there is the potential for supply constraints and further price inflation through this year. As I noted earlier, we're well positioned in this regard, and we expect to have consistent and predictable access to supply. We also expect to be able to continue translating higher product prices into increased sales and gross margin dollars, thanks to our price pass-through model.Strategically, our focus will be on continuing to pursue growth opportunities, and we're well positioned to do so. Our balance sheet's in excellent shape with significant liquidity, cash-generating ability and no term debt. This enables us to act on opportunities to win new market share, advance our product and technology strategies and take advantage of growing demand. We're also well positioned to pursue further acquisitions and are active in evaluating potential transactions. We have a strong track record of completing accretive acquisitions, and there remains significant opportunities in our highly fragmented industry.Overall, the business is in excellent shape with powerful market tailwinds, scale and service offering that differentiates us from our competitors, clear opportunities and strategies for growth and the ability to efficiently translate sales and margin gains to the bottom line. So the year ahead looks very promising. We're optimistic about our ability to continue creating value for shareholders. With that, I thank you for your attention. I'll now turn the call back to today's operator, Joanna, to provide instructions for the Q&A period. Joanna?

[Operator]

[Operator Instructions] First question comes from Roshni Luthra at CIBC Capital Markets.

[Roshni Luthra, Research Analyst]

Congrats on the good quarter. Rob, I wanted to ask you, can you tell us where prices are year-over-year for hardwood, plywood, hardwood lumber and doors?

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

So the -- as I think you know, Roshni, there's not great indices or real transparent indexes that we can look at year-over-year, it really depends even within hardwood lumber, on your species mix. But what I would say is that as we came through 2020, we talked about we didn't have a lot of price inflation in the prior year, and we started to see that emerge in the first quarter and accelerate, frankly, through the first quarter. So in some product categories, we're looking at double-digit increases. In others, it's more mid- to high single-digit increases. On a mix overall, as we look at our Q1 results, as we've said, we had about 10% organic growth, another 10% of acquisitions growth. Within that organic growth piece, we think about half and half would be attributable to higher volumes versus higher product prices.

[Roshni Luthra, Research Analyst]

Okay. Great. And then just on M&A. Can you tell us where you're seeing opportunities right now? And do you see potential for larger-scale M&A?

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

So yes, there's a couple of ways to think about that. We are seeing active or having active discussions. So the normal pipeline opportunities, which we've nurtured and built over the years, the owners of those businesses, after having come through COVID, are very much open to talking about transacting. So that's encouraging and those are underway. In terms of larger and more scale transactions, we've said all the way along that we absolutely will consider those, but there's just -- there are fewer and far -- further between. But that's not to say that we don't have opportunities that are coming across our desk that we're considering.

[Operator]

The next question comes from Jeff Fenwick at Cormark Securities.

[Jeffrey Michael Fenwick, MD & Head of Institutional Equity Research]

So I just wanted to start my questioning on the gross margin line, some continued improvements there. You did call it some of the higher pricing is helping you in the quarter. And I know in the past, things like mix such as doors and health also. So just trying to get a handle here on how sustainable this is? And if we do see continued supply constraints and higher pricing, is there room for this to move much higher? Or how are you feeling about the margin at this point?

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

Yes. No, it's a good question. And you'll know and historically, we've kind of operated in the 18% to 19% gross profit margin range. More recently, we've certainly been at the top end of that range. And this quarter, we were at a record almost at 20%. There's a few things going on within that. I do think the -- we've made improvements to our product mix over time, which has brought us to the higher end of the historical range and now beyond, is one factor that's contributed, and I see that as continuing and ongoing. We've recreated our import business, which carries with it some favorable margins, and that's also been helpful.And again, I think that, at this point, looks sustainable to us. And then we've probably got a bit of an impact here with running product prices, where we've had good margin discipline. We've managed through that well. That's given us a bit of a short-term lift, which may or may not be permanent. But I think as we look out over the next several quarters, anyway, Jeff, we think that, that's probably going to be a trend that continues for now. So I'm not sure I'm ready to say it's going to get bigger, but we're not uncomfortable with where it's sitting today in the short term.

[Jeffrey Michael Fenwick, MD & Head of Institutional Equity Research]

Okay. Yes, that's helpful color. And second question here on OpEx. I mean you guys have done a great job here on managing that and holding it steady. I guess at some point, as volumes continue to accelerate here. Is there a bit of a catch-up that has to happen, or do you think you can still have that operating leverage continue to help you over the course of the year?

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

Yes. So operating leverage is not infinite. There's obviously step changes to it. So we had very good operating leverage come through those Q1 results, it's pretty clear. When we mentioned we had about 10% organic growth, and we said half and half is organic versus -- or partly is volume versus pricing. So if you think of it that way, we've had a mid-single-digit volume increase, rough and dirty, but we've kept our operating expenses about where they were a year ago. I do see some moving up in that. Over time, naturally, you're going to add more trucks. As you move more product, you're going to add more staff, whether it's in the warehouse or on the sales side of the business. So it really did pay in Q1, but there's going to be some natural increases to costs here over time, but we're going to manage that well as well as do proportionately with how we're growing our top line.

[Jeffrey Michael Fenwick, MD & Head of Institutional Equity Research]

And then maybe just one last one on the volume you're seeing. You gave us some commentary that your performance tends to lag a little bit when you see that initial movement in housing builds and the repair/remodel. Are we just at the front end of that now? I imagine we started to see the recovery through the back half of last year, and you say maybe 6 to 9 months. So is this just sort of the beginning of it? I mean I was thinking Q1 as being seasonally weak anyway. In terms of the outlook here, is there just more of this sort of pent-up or demand coming to you that should be very helpful as we go through the year?

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

Yes. I do think that's the case. So -- and Q1 is typically a more -- a seasonally slower quarter. It was obviously a great quarter. We do see that pent-up demand. I mean there's obviously all the interrelationships within the economy. So we keep our eye on labor, not so much at our end, where it's stable, but installed labor. We're selling to customers that are making things that end up going into a home or a commercial application. So is there the skilled labor to install that? Is there product availability to -- for our fabricated customers to complete all of the projects they've got underway?So there may be some pinch points. I think that, that's a reasonable statement to make. But from our perspective, we manage the business very long term. And if there are pinch points to work through, it just means a more elongated and longer demand run from our perspective. So we look at it multiyear that whether it's low interest rates in terms of people being able to get mortgages or millennials entering their 30s, which is typical first-time homebuyer age, more demand we've seen through the pandemic. Lots of workers put a lot of money in their pockets during the pandemic, frankly, because they weren't spending it on other things. So the long-term dynamics for demand, we think are very strong for the products that we're selling. If there's any short-term supply chain or labor or other issues that hold back, I think it just stretches out that demand profile.

[Operator]

[Operator Instructions] Next question is from Zachary Evershed at National Bank.

[Zachary Evershed, Analyst]

Congrats on the quarter. So digging into gross margins a little more. In an inflationary environment, of course, you can get a boost from buying the inventory low and selling it at a higher price a few weeks later, but that does disappear when your pricing levels out. So how much of the improvement in the gross margins do you think you might get back if pricing does level out in quarters ahead?

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

That sounds a lot like Roshni's question. So yes, very close. We -- I guess, I would say, in fact, as I pointed to before. Product mix, our import business, those 2 factors we see as very strong and fundamental and ongoing. Yes, more transitory impacts on gross margin in product price inflation environment. Yes, it can be more less permanent in nature. So we're at high 19s, almost 20%. You have to make your own kind of assessments, which of those 2 factors -- or how much of each of those 2 factors contribute, Zach. But I would emphasize operating at the high end of our historical range, and those other 2 things that I just noted, we do see that as quite sustainable.

[Zachary Evershed, Analyst]

That makes sense. And then on your OpEx, very tight control, I understand that naturally that's going to have to go up as you add some trucks and staffing with the organic growth. But on the acquisition addition, River City and Aura, do you have any -- stripping any costs out of the amount that they've brought?

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

Yes. I mean, every acquisition that we do, we have a responsibility to look at if there's any duplicate expenses. But I will say our acquisitions team is typically one more of bringing things to the table as opposed to taking them off. So whether that's gross margin enhancement or bringing in new products that enable top line growth. That's typically more where we find synergies. On the cost side, yes, we do some things. We've consolidated, for instance, facility coming out of the Aura acquisition with an existing facility that we had because that made sense from a logistics and customer service perspective to do so, and that took some cost out. But past that, I wouldn't point to big cost reductions coming out of either River City or Aura.

[Zachary Evershed, Analyst]

Last one for me. What's driving the differences between U.S. and Canadian markets for your products?

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

So when you look at the Canadian market, we had stronger growth there. And I would point to -- there's a few factors in that. It's obviously a good demand environment. We've picked up new customers. And I wouldn't underestimate the impact of supply. So there's been some supply gaps that we've been able to fill in the market that -- where we've had good availability and some of our competitors have not had the same capabilities. So that's been a bit of an extra boost to our Canadian business relative to the U.S.

[Operator]

There are no further questions. You may proceed at this time.

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

Okay. Thanks, Joanna, and thanks, everyone, for dialing in today. Appreciate the interest and your questions. And do follow-up directly with Faiz or I, if you've got additional thoughts. Happy to take your call. Have a great day.

[Operator]

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