Hardwoods Distribution Inc

TSX:HDI

Earnings Call Transcript 2022-Q1

[Operator]

Good day, and welcome to the HDI's First Quarter 2022 Results Conference Call. Today's conference is being recorded.

At this time, I'd like to turn the call over to Ian Tharp. Please go ahead.

[Ian Tharp, executive]

Thanks, Christina, and Good morning to those joining today as we discuss HDI's financial results for the first quarter of 2022. My name is Ian Tharp, Investor Relations for HDI. And joining me on the call today are Rob Brown, HDI's President and CEO; and Faiz Karmally, Vice President and CFO.

HDI's Q1 2022 earnings release, financial statements and MD&A are available on the Investors section of HDI's website at www.hdidist.com. These statements have also been filed on HDI's profile on SEDAR at www.sedar.com.

Before we start, I want to remind listeners that during this call, management may make forward-looking statements. These statements involve various known and unknown risks and uncertainties and are based on management's current expectations and beliefs, which may prove to be incorrect.

Actual results could differ materially from those described in these forward-looking statements. Please refer to the text in HDI's earnings press release and financial filings issued today or yesterday, for a discussion of the risks and uncertainties associated with these forward-looking statements. Also, note that all dollar figures referred to today are in US dollars, unless today speakers state otherwise.

I'd like to now turn the call over to Rob Brown. Rob?

[Robert Brown, executive]

Yes. Thanks, Ian, and Good morning to those joining us today.

We're pleased to share with you details of HDI's record setting results for the first quarter of 2022. I'll start today with our key financial and business highlights for Q1. Faiz Karmally, our CFO, will then provide further detail on our financial results. I'll then finish off today's prepared remarks with our outlook.

In the first quarter, we set new all-time highs for sales, adjusted EBITDA and profit per share. Our results were driven by a combination of favorable market conditions, strong execution on the operating and strategic fronts, and the positive impact of our 2 most recent acquisitions.

As it relates to the market, conditions continued to be robust. Supply chains in the first quarter remain tight for several product categories we sell and more balanced in others. Overall, we continue to benefit from a strong pricing environment. At the same time, our size and scale as one of the largest architectural building products companies in North America continued to be a competitive advantage, providing us with diverse domestic and import product sourcing office.

Demand was also very good, supported by strong fundamentals in our end markets. Our teams executed well in this environment. We achieved organic sales growth of $115 million, or 39%, as compared to the same quarter in the prior year. In addition, we had significant sales contributions from the recently acquired Mid-Am and Novo businesses, adding $245 million, or 84% sales growth compared to Q1 of 2021.

You will recall that Mid-Am and Novo represent significant and transformational acquisitions for our company. Mid-Am was acquired in February 2022 and Novo in August of 2021. These additions brought us access to the attractive Pro Dealer and home center customer channels. They also significantly increased our addressable market to sell architectural building products. Mid-Am and Novo meaningfully enhanced our growth trajectory going forward and combined are expected to [ contribute ] $2 billion in sales in 2022. I'm pleased to report that both of these important transactions are performing well and in line or ahead of expectations. And the potential for achieving meaningful synergies together remain strong.

The combination of organic growth plus acquisitions resulted in significant consolidated sales growth of $354 million in the first quarter. This was up by 121% as compared to Q1 of 2021. This record sales result was paired with a strong first quarter gross margin performance. Gross profit percentage was 22.9%, up sharply from 19.9% in Q1 2021. The increase in gross margin percentage reflects several factors. This includes our ability to execute in current market conditions, successful implementation of internal pricing strategies, improved product mix, and a higher gross margin profile from acquired businesses.

In summary, first quarter supply remained tight, while product demand was strong. We increased organic sales significantly and acquisitions contributed additional growth. We achieved robust gross margins to accompany that sales growth. And at the same time, operating expenses remained well controlled across the organization, falling as a percentage of sales. These factors all combined to drive record quarterly profit, with profit per share up over 200% to $1.83 and Adjusted EBITDA up 210% to $80 million. It was an excellent first quarter for HDI.

I'll return later to talk more about our outlook. However, I'd like to now pass the call over to Faiz to review the Q1 2022 financial results in some more detail. Faiz?

[Faiz Karmally, executive]

Thanks, Rob, and Good morning, everyone.

I'm going to provide an overview of our results for the first quarter of 2022. I'll also outline our financial position and capital allocation plan. Again, I'll remind those listening that all dollar figures Rob and I use today are in US dollars, unless we've stated otherwise.

Starting with consolidated revenue, our Q1 sales were $644.9 million, which was an increase of 122%, or $353.7 million from Q1 in 2021. Focusing in on our organic sales, as Rob mentioned, market demand remains healthy and supported higher unit volumes and higher product prices. Organic sales accounted for $114.7 million, or 39.4% of the sales growth. And acquired businesses contributed $245.4 million, or 84.3% of our year-over-year growth in sales.

The acquisition-based sales growth is comprised of contributions from Mid-Am of $52.5 million, representing 7 and a half weeks of their results and $192.9 million in sales from Novo. Our US operations generated Q1 sales of $591.2 million, which was 134% higher than Q1 of last year.

US-based sales increased by $338.9 million, with organic sales growth accounting for $99.9 million, or 39.6% of the sales growth, and acquired businesses accounting for the remaining $245.9 million of the total sales growth. These sales gains were partially offset by $6.4 million reduction in sales related to the divestiture of our HMI business in Q1 of last year.

Our Canadian operations made strong contributions in Q1 as well. Canadian sales for the first quarter of 2022 rose by CAD18.8 million, which was a 38% gain compared to Q1 in 2021. This result was entirely driven by organic growth.

Turning next to gross profit. We posted a 155.3% improvement to $147.8 million in Q1 of 2022. This substantial growth was supported by our record sales results, contributions from Novo and Mid-Am, and the delivery of a strong gross profit margin percentage. Our Q1 gross margin of 22.9% is 300 basis points higher than the level we posted in Q1 of last year. This result reflects an increase in selling prices without a corresponding increase in costs, changes in sales mix, successful execution of our internal strategies and the inclusion of Novo and Mid-Am's higher margin product mix in the first quarter.

Our operating expenses for Q1 were $84.8 million, which were $45.8 million higher than the first quarter of 2021. The increase in operating expenses primarily relates to the operations of Novo and Mid-Am, which accounted for $35.3 million of the increase. We also incurred an additional $6.6 million related to investments to support our growth, and amortization of intangible assets, which were acquired in the Mid-Am and Novo transaction of $4.1 million. As a percentage of sales, operating expenses decreased to 13.1% as compared to 13.4% in Q1 of 2021.

Moving now to adjusted EBITDA. For Q1 2022, it climbed 210% year-over-year to a record level of $79.8 million. As a percentage of sales, our Q1 adjusted EBITDA margin was 12.1%, a significant improvement from the 8.6% adjusted EBITDA margin posted in Q1 of 2021. We continue to benefit from the operating leverage available across our expanded platform as we grow our profitability. Q1 profit of $43.5 million represented a 235% year-over-year growth rate. And our per share profit climbed to $1.83, an increase of over 200% from $0.61 per share posted in Q1 of 2021.

Turning our attention to the balance sheet. As of March 31, 2022, our leverage ratio, which is the ratio of our net bank debt to adjusted EBITDA after rents, was 3.3x. We remain well within leverage and interest coverage ratios required by our current debt facilities. And we continue to expect our leverage ratio to be comfortably below 3x by the end of 2022, notwithstanding the impact of potential future acquisitions.

We ended the first quarter with significant unused borrowing capacity of $170 million. Our capital allocation priorities are focused on responsible management of our balance sheet growth, both organically and through accretive acquisitions, and providing incremental total returns to shareholders through our dividends and share repurchases.

With that, I'll turn the call back over to Rob. Rob?

[Robert Brown, executive]

That's great. Thanks, Faiz. I'll finish our prepared comments this morning with our views on end markets and our strategy to continue to build the long-term value of HDI. From a demand perspective, our customers today continue to be very busy. While interest rates have increased in recent weeks and are expected to rise further as central banks work to slow inflation, mortgage rates remain well below their historical trend and demand for housing continues to significantly outstrip supply in the markets we serve.

On a multi-year basis, we believe that there are longer-term structural tailwinds that our business will benefit from. These include; supply is materially constrained. There's a severe housing deficit, driven by 10-years of underbuilding, resulting in a shortfall estimated to exceed 3 million units. We supply products to an essential area of the economy, including residential construction, repair and remodel and numerous commercial applications.

Our customers are the backbone of the US construction industry and include industrial manufacturers, Pro Dealers and home centers. Savings rates spiked during the pandemic. Individuals have disposable income to spend against home and R&R projects. And increasingly, intergenerational wealth transfers is also a helpful source of capital. Millennials are the largest segment of the population, and they're in peak home buying years.

Home equity levels are at all-time highs, providing liquidity to fund housing expenditures. And the age of homes in the US is also at an all-time high, requiring R&R spending to maintain. For these reasons, we remain bullish on the demand outlook for our products and continue to see that activity today. However, in the event that an economic downturn were to emerge, it's key to understand the downside strengths built into our business model.

From a financial standpoint, we maintain a strong balance sheet, which provides significant financial stability. Our business model converts a high proportion of EBITDA to operating cash flows before changes in working capital. And importantly, our operating track record shows that during periods of reduced economic activity, we naturally release working capital investment, resulting in an additional source of cash.

I would also highlight the following characteristics of the business profile of who HDI is today, which provides stability benefits in all market cycles. Ours is a business that is diversified by customer and supplier. We maintain 86 locations across North America, limiting our geographic exposure to any one region. We sell a diverse and specialty product set with no one product category exceeding 20% of our sales.

We maintain a strong balance sheet and generate significant cash flow, as noted. The company has strong growth prospects both organically and through our acquisitions program. The architectural building products market is fragmented, and there remains significant market share for us to capture. And the management team has a long tenure with a proven track record of performing in varying market cycles. We have a consistent track record of growing the business profitably. Our total shareholder returns have generally outpaced the TSX and TSX SmallCap Index.

I'll close my opening comments by acknowledging that despite our positive outlook and business profile, as I've just outlined, our stock price and valuation has traded downwards recently. This is consistent with the broader trend we've seen -- we've all seen in the stock market. In light of this, we believe that the market price of HDI's common shares may not reflect the underlying value of the company. In March and April, we repurchased 57,000 common shares for CAD2 million. We intend to continue to actively assess share repurchase levels as an important component of our capital allocation plan going forward.

So with that, I thank you for your time this morning. I'm going to ask our operator, Christina, to please provide instructions for the Q&A period. Christina?

[Operator]

[Operator Instructions] And we'll take our first question from Meaghen Annett with TD Securities.

[Meaghen Annett, analyst]

Just starting off with the organic sales growth in the quarter. Could you break out pricing gains versus volume growth there? And if you could also update us on what you're seeing in terms of pricing across your products today, that would be helpful.

[Faiz Karmally, executive]

Meaghen, it's Faiz here. I can take the first part of your question in terms of our results and our sales growth and how much of that was pricing versus volume. Just a quick reminder, I know some on the call will be familiar, the pricing versus volume question is a little difficult with our business, just given the number of SKUs we sell and what we sell being a specialty product and then because it's a regional business. Even for same or similar SKUs, you could have different -- a little bit different pricing in different regions. And because we're not selling a uniform product, it's not really a simple exercise, but we do have an estimate of that. I can share with you. And if we look at our growth in the first quarter, we think the majority of that was price driven. We did have some volume gains, but I would say more price than volume.

I'll turn it over to Rob for the second part of your question.

[Robert Brown, executive]

Yes. And in terms of product categories, I'll touch on a few, and you may want to reference the product portfolio from our investor presentation. But generally, I would say that from a domestic sourcing perspective, things remain relatively tight from a hardwood lumber, hardwood plywood and composite product category perspective. Same would be true for doors. I would say better supply-demand balance in moldings, and also in some of our offshore hardwood plywood product categories.

And then stare parts remains reasonably tight as well. So I mean, I guess the comment I would make is when you look at the comps in the MD&A, that's obviously year-over-year, and prices are up significantly in Q1 this year versus Q1 last. As between Q4 and Q1, we've generally seen as an overall statement, prices finding a little bit more stability. They're not contracting, but they're not going up at the same rate that we saw last year.

[Meaghen Annett, analyst]

And then in terms of the M&A pipeline, are you seeing any shift in the available opportunities, more or less opportunities than 6 months ago? And with the access to expand addressable markets, are you in a position today to give some color as to the size and scope of the opportunities in the pipeline?

[Robert Brown, executive]

Yes. So think about -- I guess, I'll first deal with the availability shift. There's still very good volume of potential candidates that are on the market. We got a whole lot of M&A done last year. As you know, we're being quite selective, but we are still actively looking at opportunities and ones that fit well with the strategy and that we feel are well priced, we will still be in the market for.

In terms of access to addressable market, you can think of that in 2 buckets. One is the traditional industrial customer base that the company has had. That is numerous. There's hundreds of names in that pipeline, and they generally tend to be smaller to midsized. And we like those. They're good tuck-ins and they can be very good strategic adds on a geographic basis. On the home center, pro side, which is where Mid-Am and Novo live, yes, we've got a very good handle on the opportunity set that's in that market. And those tend to be, I would say, fewer number names than you would see on the industrial side and generally a little bit larger in scale, but there's also a good opportunity there as well.

[Operator]

We go to our next question from Jeff Fenwick with Cormark Securities.

[Jeff Fenwick, analyst]

So guys, I just wanted to start my questions with working capital and inventory in particular. You've called out you're continuing to carry a bit higher level of overall inventory just to make sure you can meet that demand. Any sense here, like when that might start to ease? I mean, if you work that lower, obviously, you could free up quite a bit of cash for the business. What's your positioning as we sort of head into the summer season?

[Robert Brown, executive]

Yes. The demand is there. So it's what you said. We've wanted to make sure we've got -- make sure we've got sufficient product to meet the needs of our customers, which has been, as I said earlier, robust. I do see that kind of plateauing. We're in -- in terms of the inventory, not the demand at this point, we're in a very good position with what we've got today. We are carrying more than we traditionally would because of fragmented supply chain. So that's a deliberate decision to do that. But I do think that we're kind of in good shape, and I would expect that that's going to plateau and we're going to start to bring that down and see release in the second half.

[Jeff Fenwick, analyst]

Great. And I think I asked that question to you in terms of freeing up the cash and prioritizing paying down debt. I mean, you're in a period now, obviously, where very favorable conditions and a lot of cash flow. So what's the prospect of maybe delevering a bit faster than you're suggesting the sort of targeting just below 3 by the end of the year or comfortably below 3. So how do you think about prioritizing cash flow in the business?

[Robert Brown, executive]

Yes. So as you just identified, that working capital piece is a component to that in terms of pace of delevering. I feel like we have quite good control over that. So that is a lever that we can kind of pull. But in terms of the overall cash usage, we're consistent with where we've been in the past. We'll fund the business and the working capital needs. But as I described, we see pulling some dollars out of that as opposed to investing more as we move through the year.

We are going to look at acquisitions that are available to us. But I would say we're going to be quite selective. We do have an eye on releasing some cash and paying down debt. And we think that's prudent in the higher -- slightly higher and certainly, we've just got in the market today. And the other piece is the share repurchases. We did activate that, as I mentioned in my comments in March and April, and we think the current share price is dislocated and not representative of the value of the company. So, that will also be part of the thought process.

[Jeff Fenwick, analyst]

Okay. And then maybe just one on pricing. I think what we've seen through the cycle here is just how quickly those prices have moved higher across many of the products that you're distributing. What are your thoughts around prices beginning to move lower? Like what would it take for that to -- that pressure to abate? And do you think the pricing could move lower just as quickly as it went up? Or is it more likely to be a bit more of a gradual drop-off?

[Robert Brown, executive]

Yes. I'm always cautious of anyone who says they know the future. So, these are just my own views. I think that the -- if you look structurally at the market, the degree or the lack of supply in housing is relative to the demand that is there is substantial. So, we recognize some of these potential demand dampeners, higher inflation and mortgage rates, conflict in Ukraine. But our view is that's not going to overwash those underlying deficit in people's needs for housing and shelter and all the products that we supply that go into that.

So, we continue to think that if there is going to be a price reduction, it shouldn't be severe. I think more rolling hills than peaks and valleys. Can there be a pullback in product pricing and categories over time? Of course. But what we've done is really tried to diversify the business in terms of the product portfolio we participate in to provide more stability to that. And then you've seen how we execute within whatever market conditions do come to us. So, we think we can put good points on the board really regardless of cycle.

[Operator]

[Operator Instructions] We'll take our next question from Zachary Evershed with National Bank Financial.

[Zachary Evershed, analyst]

Congrats on the quarter. Q2 usually sees a seasonal uptick in revenue quarter-over-quarter, given the strength that we saw in Q1, do you expect usual pattern will still hold through this year?

[Robert Brown, executive]

Yes. Seasonality has been more muted and less predictable as of late. I mean, look at our Q4, we really didn't see the diminution we would typically see in Q4. So Q1 was very strong. I think it's hard to say what Q2 will precisely bring. But if we saw a more muted seasonality pattern than maybe in the past that wouldn't surprise me. We're already operating at a very high level.

[Zachary Evershed, analyst]

That makes sense. And then are you seeing any signs of overseas logistics untangling or freight costs easing in your claims?

[Robert Brown, executive]

It's still pretty competitive out there, to be honest. And there's multiple points of delay that -- whether it's overseas production, getting product to ports, warehousing at port, then getting it loaded, takes longer to get here, takes longer than load and then storage facilities on dock in North America are also tight. So, that is actually a contributing factor to the extra inventory dollars that we've not just chosen to hold, but have had that hold because the import supply line is just elongated today relative to where it was previously on freight. We're not seeing a lot of relief at this point, Zach.

[Zachary Evershed, analyst]

Great color. And then last question. Are you getting a better sense of what you'd consider a sustainable gross margin level?

[Faiz Karmally, executive]

Zach, it's Faiz. I could take that question. I don't have a number for you. But the way I would describe it maybe as the things that we've talked about that are impacting gross margin, and there's a number of them. And we talked about some being transitory and others not. So maybe I'll stick with the ones that are a little more transitory. I mean, they're still strong and impacting our business. We saw a gross margin of 22.9% in Q1. It was pretty close to our trend over the last couple of quarters. So, I think we've talked about that as settling higher than our traditional sort of a couple of years ago, you might remember the 19% was sort of a plus or minus. It's going to settle higher than that. It doesn't stay at these levels, I'm not sure, but I certainly think it's within that range still. So, that's how we're kind of approaching it, [ which you need to see ].

[Operator]

[Operator Instructions] It appears there are no further questions at this time. I'll turn the call back for any additional or closing remarks.

[Robert Brown, executive]

I think that's it for today. Faiz and I are always available for follow-on questions. Do reach out if you've got one. And other than that, we'll put a wrap on it, Christina. And thanks, everybody, for joining the call today.

[Operator]

This concludes today's call. Thank you for your participation. You may now disconnect.