Hardwoods Distribution Inc

TSX:HDI

Earnings Call Transcript 2023-Q1

[Operator]

Good morning, ladies and gentlemen, and welcome to ADENTRA’s First Quarter 2023 Results Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Friday, May 12, 2023.

I would now like to turn the conference over to Mr. Ian Tharp, Investor Relations. Please go ahead, sir.

[Ian Tharp, Investor Relations]

Thanks, Laura, and good morning to those joining today as we discuss ADENTRA’s financial results for the first quarter of 2023. With me on the call today are Rob Brown, ADENTRA’s President and CEO; and Faiz Karmally, Vice President and CFO.

ADENTRA’s Q1 2023 earnings release, financial statements and MD&A are available on the Investors section of our website at www.adentragroup.com. These statements have also been filed on ADENTRA’s profile on SEDAR at www.sedar.com.

I want to remind listeners that management's comments during this call may include 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 ADENTRA’s earnings press release and financial filings for a discussion of the risks and uncertainties associated with these forward-looking statements. All dollar figures referred to today are in U.S. dollars unless stated otherwise.

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

[Rob Brown, President and Chief Executive Officer]

Thanks, Ian. Good morning, everyone. I am pleased to speak with you this morning as we report ADENTRA’s financial and operating results for the first quarter of 2023. I'll start with our key financial and business highlights for the quarter. Faiz Karmally, our CFO, will then provide details of our Q1 financial results. I'll finish off today's prepared remarks with our outlook for 2023.

We generated $580 million in sales, $43 million in adjusted EBITDA, adjusted earnings per share of $0.48 and $70 million of cash flow from operating activities in the quarter. As described in our previous outlook, rising interest rates were expected to reduce demand for architectural building products in the near-term. We anticipated reduced financial performance in 2023, as compared to the record-setting levels achieved in 2022.

First quarter results were in line with this expectation. Organic sales decreased year-on-year by 13.8%, primarily driven by lower volume demand, as compared to the record-setting pace in 2022. Lower organic volume demand was partially offset by a 4% sales increase contributed by acquired businesses, such that total sales were down by a lesser 10%.

Gross profit percentage also performed as expected, coming in at just over 20% for the quarter. Expenses were well controlled, despite continued general cost inflation that persists in the economy. Despite the impact, softer demand conditions had on sales and bottom line earnings, cash flow from operations was strong and increased by $100 million year-over-year.

We demonstrated the business’ ability to generate significant cash flows during periods of reduced economic activity. Cash flow generation came from both the predictable conversion of adjusted EBITDA to operating cash flow before changes in working capital and from the release of working capital.

We put the substantial cash flow generated during the quarter to work, financing the purchase of Rojo Distributors, repurchasing almost 2% of our outstanding shares, announcing a quarterly dividend of [CAD0.13] (ph) per share and paying down net bank debt by $43 million in the first quarter.

As we move forward, we will continue to closely monitor changing economic conditions and the impacts of recent inflation, rising interest rates and other factors that can have an effect on our business.

I'll return to speak more on our outlook later on, but I'll now pass the call to Faiz to review the Q1 2023 financial results in more detail. Faiz?

[Faiz Karmally, Vice President and Chief Financial Officer]

Thanks, Rob, and good morning, everyone. I'm going to provide the details of our financial results for the first quarter of 2023 and outline our financial position at quarter end. Again, I'll remind those listening that any dollar figures Rob and I are using today are in U.S. dollars unless we stated otherwise.

Starting with consolidated revenue, we generated sales of $579.9 million in Q1, which was a decrease of 10.1% or $65 million, compared to the first quarter of 2022. Organic sales decreased by $88.7 million or 13.8%, primarily reflecting lower volumes. This was partially offset by a $26.4 million or 4.1% increase in Q1 sales sourced from acquired businesses, which include Mid-Am acquisition, which we closed in February of 2022, as well as Rojo Distributors closed in February of this year.

Also contributing to the Q1 decline in sales was a $3 million unfavorable FX impact, due to the translation of our Canadian sales to U.S. dollars for reporting purposes. Focusing regionally, sales in our U.S. operations were $536.2 million, which was 9.3% lower than the corresponding quarter in 2022. Organic sales in the U.S. decreased by $81.7 million or 13.8%, as compared to Q1 of the prior year, and this change was largely volume-driven. This was partially offset by increased acquisition-based sales from Mid-Am and Rojo of an additional $26.4 million.

In Canada, Q1 sales were CAD59.1 million, which was 13.2% lower than the same period in 2022. Similar to the U.S. market, the decrease in Canadian sales, primarily reflects lower volumes.

Turning to gross profit. We earned $117 million in the first quarter, a 20.8% decrease, as compared to Q1 in 2022. This change reflects lower organic sales and a gross profit percentage of 20.2%, as compared to 22.9% in the same period last year. Our gross profit percentage in the prior period was temporarily elevated, due to favorable market dynamics, including strong demand and tight supply.

Our operating expenses for the first quarter of 2023 were $92.4 million or $7.7 million higher than Q1 of 2022. $4.3 million of this increase is related to incremental operating expenses and intangible asset amortization from our acquisition of Mid-Am and we incurred $3.4 million in organic cost increases.

I would note that despite higher inflationary conditions prevalent in the economy, the incremental organic expenses represents just a 4% increase, as compared to the same period in the prior year.

Moving now to adjusted EBITDA. For Q1 2023, it was $42.9 million, a decline of 46% that was primarily driven by decreased Q1 gross profit margins and the increase in operating expenses, as I mentioned earlier. As a percentage of sales, our adjusted EBITDA margin was 7.4% for Q1 of 2023, as compared to 12.4% in Q1 of 2022.

Finally, Q1 profit was $9.6 million, a decline of $33.9 million from the same period in 2022. This change was driven by the reduced EBITDA mentioned earlier, increased depreciation and amortization of $1.8 million and $6.8 million of additional finance expenses, offset by an $11.4 million decrease in income tax expense.

On a per share basis, basic profit was $0.43 in the quarter, as compared to $1.83 in Q1 of 2022. Looking at our operating cash flow for the quarter. This increased $100 million to $69.8 million year-over-year. Of this amount, $49.1 million was generated from the reduction in inventory levels in the first quarter.

Moving next to our balance sheet. Our strong cash flow generation enabled us to reduce debt by a total of $49 million, bringing the amount of debt we have repaid in the past year to a total of $213.7 million. We exited Q1 in a solid financial position with a leverage ratio of 2.6x and unused borrowing capacity of over $325 million.

Our strong balance sheet shows the resilience of our business model and provides us with ample flexibility to manage any short-term headwinds, fund future growth and continue to advance our business strategies.

Our capital allocation strategy remains intact and prioritizes the continued responsible management of our balance sheet, funding our organic and acquisitions-based growth and providing incremental total returns to shareholders.

As outlined during our Q4 2022 results call, in February of 2023, we completed our small tuck-in acquisition of Texas-based Rojo Distributors as part of our ongoing M&A efforts. With respect to returns to shareholders through a combination of dividends paid and share repurchases, we returned a total of $11.4 million to shareholders in Q1 of 2023.

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

[Rob Brown, President and Chief Executive Officer]

Thanks, Faiz. I'll conclude my comments this morning with our views on end markets and details on our strategy to continue building the long-term value of ADENTRA. In the near-term, we continue to expect that previous inflation and increases in interest rates will have a negative impact on economic activity. In turn, this is anticipated to result in reduced organic product demand and could lead to softer product pricing and volumes as compared to prior periods. As a result, and as we experienced in the first quarter, we expect our financial performance in 2023 will not be as strong as the record-setting levels achieved in 2022.

With that being said, we remain confident that our business continues to be well positioned to weather the more challenging market conditions expected in 2023. As we outlined in detail during our Analyst Day last December, over the past two years, we've significantly grown and broadened our market access. Our end market participation now gives us strong access to customers in the residential construction, repair and remodel and commercial sectors.

Our channels to market have been expanded to industrial manufacturers, home centers and pro dealers. And our product mix is diverse with no one product category exceeding 20% and the majority of the mix comprising higher-margin specialty products installed in the finishing stages of a project. The scale of our platform, combined with our broad end market participation, expanded channels to market and diverse product mix are valuable sources of stability for our business model and we believe they reduce our exposure to any one geography or segment of the economy.

And as demonstrated over the last several quarters, our business converts a high proportion of EBITDA to operating cash flow before changes in working capital. In periods of reduced economic activity, our ability to release working capital is an important additional source of cash. We also maintain a strong balance sheet and over $325 million of undrawn liquidity on our credit facilities.

Over the longer term, we expect demand for our products to remain robust, supported by strong fundamentals in the residential, repair and remodel and construction markets. These fundamentals include high levels of home equity in the U.S., a median home age of over 40 years, housing starts having meaningfully lagged population growth over the last decade and positive demographic factors driving the demand for living spaces.

In addition, we estimate our share of the addressable market to be 6%, and we've outlined and remain focused on pursuing our Destination 2026 goals to achieve run rate sales of $3.5 billion by 2026. Further details of this can be found in the December Analyst Day presentation on our website.

With that, I want to thank you for your time this morning. I'll now turn the call back to Laura to provide instructions for the Q&A period. Laura?

[Operator]

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from the line of Gabriel Nicholson from CIBC Capital Markets. Please go ahead.

[Gabriel Nicholson, CIBC Capital Markets]

Hey, everyone. Hope you are doing well.

[Rob Brown, President and Chief Executive Officer]

Good morning, Gabriel.

[Gabriel Nicholson, CIBC Capital Markets]

In the press release, you mentioned pricing was stable year-over-year. I was just wondering if you could provide some more color in terms of the sequential changes as well as any changes by product category?

[Rob Brown, President and Chief Executive Officer]

Yes. I think it will be probably a little bit disorderly to go through all the product categories. But on a sequential basis, it's a good question. We've generally seen very low single-digit month-over-month changes in pricing where it's been declining. We've been putting volume gains on the board of a similar amount. So all-in-all, flattish as we've kind of moved through the first quarter there.

[Gabriel Nicholson, CIBC Capital Markets]

Okay. Great. And then second question, how is the M&A pipeline looking and have you seen any change in vendor expectations?

[Rob Brown, President and Chief Executive Officer]

M&A pipeline is quite active. We've -- as always, we've got a number of conversations ongoing, but I would describe some very good opportunities available to us. It's hard to make a generalized statement around seller expectations. I would say there's a general recognition that building product companies have just enjoyed an extremely good period of demand and success and there's more reasonable expectations in terms of people understanding what sustainable EBITDA is and that pricing is based off that kind of a perspective. So we still feel very good about the activity levels we've got. As you know, this is a fully staffed resource and a critical component of our Destination 2026 plan. So we intend to continue to be active.

[Gabriel Nicholson, CIBC Capital Markets]

Appreciate it, okay. Thank you. I’ll get back in the queue.

[Rob Brown, President and Chief Executive Officer]

Thanks.

[Operator]

Your next question comes from the line of Jeff Fenwick from Cormark Securities. Please go ahead.

[Jeff Fenwick, Cormark Securities]

Hi, good morning, everybody. So Rob, I just wanted to start my questions here on the gross margin front sort of you've held steady, I guess, for a couple of quarters now. And I think in the past, you've spoken to the shift in the product mix from M&A helping you stay above that 20% level.

Can you just comment -- is there much in the way of shift in the mix in inventory that might influence the gross margin at this point? Or is it just broadly, I guess, the pace of change in pricing that you're seeing that might move that up or down?

[Rob Brown, President and Chief Executive Officer]

No, I don't think we would call it anything on the mix in inventory. We are pleased that we're holding above the 20%, that's part of our target financial KPIs, again in that Destination 2026 model. You're right, the M&A has helped with the overall product mix, but we've also done some things around better pricing discipline, the mix of import versus domestic products and our overall offering are also contributors to sustain as a more fundamental or a long-term shift in the margin to keep that above the 20%.

I would say that in the first quarter and also in the fourth quarter, we had what I would describe as generally a little bit higher inventory write-downs, which put a little bit more pressure on to the margin. But despite that, as you noted, the last two quarters have been at 20.2%.

[Jeff Fenwick, Cormark Securities]

Okay, thank you. That's helpful. And then obviously nice to be able to harvest some cash out of working capital. I mean, where are you now in terms of the positioning there? Is there much incremental to do? And I guess maybe there's some seasonal considerations here to, I sometimes think you tend to think about sometimes a bit of a seasonal build in inventory as well as you head into the mid part of the year? Like what's the situation there?

[Faiz Karmally, Vice President and Chief Financial Officer]

Yes. Jeff, it's Faiz here. I can take that one. I mean, you kind of highlighted it. In the last six months, we've accomplished quite a bit on the inventory side. I mean, the days on hand has come down as noted. But we took almost $50 million in the first quarter here. We took out just over $80 million in the fourth quarter of last year. I've talked before about our goal wanting to be kind of by the end of this year, that 80-days, plus or minus. So we're getting there. We're sort of in the mid-80s now. I think there's a little more we can do still in the inventory. To your point, I'm not sure we get a lot of that in Q2 or Q3. That might be more of a back end of the year thing.

But I think there's -- at current sales pace, there's a little more we can do on the inventory. There could be another -- to go from 85 to 80 days current sales base that could be another $40-plus million of inventory, it’s probably in the back half of the year, but I think there's a little more we can do there as well.

[Jeff Fenwick, Cormark Securities]

Okay. Great. And then maybe just one last one here. Just trying to get some context around seasonality versus the broader cycle that's playing out and Q2 tends to be seasonally better for you and do you think that's still the case this year where you could see a sequential tick up in revenue despite some of the headwinds on pricing and demand?

[Rob Brown, President and Chief Executive Officer]

Yes, I think you're right. It is a little different just with the broader cycle to say how does that cross reference against regular seasonality patterns. Yes, I mean, we certainly are looking for an uptick as between Q1 and Q2 and carrying through Q3. As you know, Q4 is seasonally a softer period of time. It's a little early to say. I think how that's going to play out in reference to my previous response to, I think, Gabriel's question, we're seeing a little bit of pricing leak month-over-month, but we're making volume gains month-over-month. So I think we need to let that play out just a little bit more.

[Jeff Fenwick, Cormark Securities]

Okay. Okay, that’s all my questions. Thank you.

[Rob Brown, President and Chief Executive Officer]

Thanks.

[Operator]

[Operator Instructions] Your next question comes from the line of Zachary Evershed from National Bank Financial. Please go ahead.

[Zachary Evershed, National Bank Financial]

Good morning, everyone. Congrats on the quarter.

[Rob Brown, President and Chief Executive Officer]

Hi, Zach. Good morning.

[Zachary Evershed, National Bank Financial]

Given what you're seeing in terms of end market demand with volumes picking up and pricing leaking quarter-to-date, where do you see gross margins going from the Q1 level?

[Rob Brown, President and Chief Executive Officer]

I think the general statement that we've made that they'll be north of -- they'll start with the two, they'll be north of 20% as our goal is unchanged at this point, Zach. And we've been running there, as I mentioned in the last couple of quarters despite taking quite a bit of inventory out of the system.

[Zachary Evershed, National Bank Financial]

Got you. Thanks. And how are you evaluating operating leverage at this point? Are you looking to cut costs to continue to maintain EBITDA margins or would you rather maintain the structure for the eventual bounce back?

[Rob Brown, President and Chief Executive Officer]

Yes. I mean there's certainly leverage in the P&L. We enjoyed that on the extremely strong demand we saw in 2022, and we're seeing the other side of that, obviously, now with less volume demand. We're always attuned to being very disciplined on costs. We've got, as you would expect, certain cost controls in place, given we're facing lower volumes right now. Having said that, we're not making a structural shift where we are making a major capacity reduction, because we see brighter times ahead when you think of the longer-term outlook that I described in my opening statements, that longer term is not that far away.

We're -- in our perspective, that's quarters away. So maintaining productive capacity as it relates to people, it's still a very competitive labor market and having the facilities, the physical working -- physical capital to move product is still very much on our agenda. But I again qualify those comments with, yes, we are being very disciplined on the judgmental spending and things that we can control in the shorter term as we do go through a little bit of a softer demand period.

[Zachary Evershed, National Bank Financial]

Great answer. Thanks. I’ll turn it over.

[Operator]

Thank you. Your next question comes from the line of Ketan Mamtora from BMO. Please go ahead.

[Ketan Mamtora, BMO Capital Markets]

Thank you for taking my questions and good morning.

[Rob Brown, President and Chief Executive Officer]

Good morning.

[Ketan Mamtora, BMO Capital Markets]

First question, Rob, I'm curious, within sort of your end markets of new resi, repair and remodeling, commercial, can you talk to, at all, kind of what the trends were during Q1 and what you've seen so far in April and sort of kind of middle of the May? Are you seeing any signs where new resi seems to be stabilizing, maybe getting a little better? Just curious kind of how they are trending in the last few months?

[Rob Brown, President and Chief Executive Officer]

Yes. Great question, Ketan. So I think what we would say on R&R versus residential versus commercial, is it lines up probably reasonably well with what we put in the outlook statements, where R&R has been a stronger performer, residential less so. We're obviously running at about 18% to 20% less starts, if you wanted to pick a metric than we were a year ago.

And commercial, we've got, has been quite steady. So on the residential, we read all the same stuff you do. We read your stuff, too. I think that there's some green shoots there in terms of what homebuilders are seeing for future orders. That really hasn't filtered through to us yet because our products are in the finishing stages, but we certainly keep a close eye on that for future demand and view it as positive.

[Ketan Mamtora, BMO Capital Markets]

Understood. And on the commercial side, Rob, is there sort of any signs of market activity easing at all or it's sort of it is what it is at this point?

[Rob Brown, President and Chief Executive Officer]

I would say the latter. I mean it just -- it feels steady. You'll recall, we have a separate specification sales force referred to as DesignOneSource, you can check that out online at designonesource.com. The reason I bring them up is they call on architectural designers to create future demand for our product, pull-through demand by getting proprietary products we have written into future construction specs.

On that front, they're very active and the number of projects that we're tracking continues to grow. So right now, I think commercial, as we've said, kind of flattish. But when we look at things that we've got in the pipeline for future, we feel good about that segment as well.

[Ketan Mamtora, BMO Capital Markets]

Got it. That's helpful. And then one for Faiz. Faiz, curious how you think about sort of approach towards share repurchases to the extent that this macro uncertainty provides any short-term sort of dislocations? And I know you talked about the M&A pipeline being quite active. So how do you balance sort of your interest to kind of grow via M&A versus opportunity for share repurchases in the broader context of leverage?

[Faiz Karmally, Vice President and Chief Financial Officer]

Yes. Hey Ketan, I would say our capital priorities are to grow the business. M&A is a very important component of that in our Destination 2026 targets and that information for those listening can be found on our website and our Analyst Day materials from December. Ketan, you -- of course, you've seen those. Our plan to get to $3.5 billion in run rate sales by 2026, a very large component of that is M&A focused. That's really -- between that and managing leverage, that's really the focus of our capital allocation. Beyond that, we're maintaining the dividend today. And then we've really taken a measured approach to share repurchases.

So I would say going forward, the balance sheet leverage, one, and our opportunities for M&A. And then, of course, just funding organic growth, those things are really the priority for capital. And I would describe maybe share repurchases as coming after that. So as Rob mentioned in our M&A pipeline, there's very good activity right now. Even in this environment, there are deals that we could potentially do that are accretive. And so that's -- if that's available to us, that's going to be the focus.

[Ketan Mamtora, BMO Capital Markets]

Got it. Now that’s very helpful. I’ll turn it over. Good luck.

[Faiz Karmally, Vice President and Chief Financial Officer]

Thank you.

[Operator]

Thank you. There are no further questions at this time. I'd now like to turn the call back over to Mr. Rob Brown for any closing remarks.

[Rob Brown, President and Chief Executive Officer]

Okay. Thanks, Laura, and thanks, everyone, for joining us today. I appreciate your interest in ADENTRA. Please do reach out to Faiz or myself or Ian, if you've got questions or follow-up comments. And thank you, again, and have a great day.

[Operator]

Thank you, sir. Thank you so much, presenters. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.