Hardwoods Distribution Inc

TSX:HDI

Earnings Call Transcript 2019-Q4

[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 Year-End and Q4 2019 Results Conference Call. [Operator Instructions] Rob Brown, President and CEO, you may begin your conference.

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

Thank you, Jessica. Good morning. Welcome, everyone. Thanks for joining us. I'm going to start this morning with some comments on how we're responding to the rapidly evolving COVID-19 situation. I'll also review some highlights from 2019. Faiz Karmally, our CFO, will follow with our fourth quarter and our full year financial results. Then I'll return to discuss our outlook before opening the call to your questions.As you know, the ground is shifting daily as the realities of the coronavirus pandemic are being felt across the world. Here at HDI, the first priority has been taking steps to safeguard the health of our employees and our customers. We moved very early to suspend all business travel outside North America. And we've since suspended all nonessential domestic travel as well. Employees who've been outside the country are required to self-quarantine for 14 days upon return. At our distribution centers and offices, we've put protocols in place to deal with the foreseeable COVID-19 virus scenarios that we might all expect to arise. This includes enhanced cleaning procedures, providing regular briefings to all employees on how to protect their health and self-quarantine guidelines for anyone who's not feeling well. We recognize the seriousness of this pandemic, and we will continue to take every step possible to protect our employees, customers and business.In terms of supply, we've experienced very little interruption to our supply chain so far. We generally stock 3 months of inventory in our warehouses and maintain very diverse supply lines. I am confident we have sufficient inventory to meet our customers' needs. As it relates to customer activity, up to this point, we have not experienced a slowdown in demand. Our customers generally remain open for business, and we continue to transact with them. Our locations continue to carry on business at this time with limited disruption, using modified operating procedures to accommodate social distancing. However, it is possible that we may start to experience demand impacts. With every passing day, governments at the local, regional and federal levels, are taking stronger steps to curb transmission of the virus. If this trend continues, it may translate to reduced economic activity. I want to emphasize that we're well positioned for these new realities. We maintain a North American-wide footprint with no significant customer concentration. This enables our business to weather headwinds that may arise in individual markets. Should we see a North American-wide slowdown or shutdown, we would rely on our significant capital resources to ensure business continuity. Our business model is well suited to fluctuations in demand. Our working capital is high quality, turns efficiently, we carry no term debt, and we convert a significant portion of our EBITDA to operating cash flow. And the investment required to maintain our infrastructure is not significant. I'm very confident in our ability to adjust to the new market conditions as we move forward. I suspect you're going to have questions related to the coronavirus impacts, and we can get into this in more detail in the Q&A. But for now, let's move on to our 2019 performance.I'm pleased to report that we achieved our 10th consecutive year of growth in 2019, achieving our best ever sales result of nearly $1.2 billion. We also improved gross profit margin to 18.1%, and we generated record cash flow from operating activities of $92.8 million. Acquisitions played an important role in our top line growth. We completed 2 transactions during the year. The first was Far West Plywood in January, which brought us a new location in Southern California. And in November, we acquired Pacific Mutual Door Company, which brought us 4 locations, strengthened our presence in the midwest, and was accretive from a bottom line perspective on day 1. These 2 acquisitions added $36 million to our 2019 results. And on an annualized basis are expected to add over $90 million of sales.On the bottom line, our results reflected a strong finish to the year. As our revitalized import program gained momentum and contributed to improved margins in the third and fourth quarters. I want to point out that our results were achieved despite a number of external challenges. As you know, 2019 got off to a tough start with lost sales days and a delayed construction season due to severe weather conditions in a number of regions. We also experienced uneven market sentiment in some of our U.S. construction markets. And while we achieved growth across the majority of our product lines in 2019, Hardwood lumber prices were significantly lower through the year as a result of excess industry supply and a shift in demand to lower-value species. Our strong performance amidst these conditions underscores the strength of our business model and our success in diversifying the business as we've grown. Our end markets are also significantly more diverse, providing us with access to more sectors of the economy. And we've greatly expanded our base of products, suppliers and customers. Growth has made us stronger, more diverse company, and this contributed to our results in a challenging year.I'm pleased to report that we had a successful year in 2019 as it relates to returning value to shareholders. In November, we increased our dividend by another 6%. This was our seventh dividend increase in 7 years. We also returned $3.4 million of cash to shareholders through share buybacks. In total, our cash returns to shareholders totaled $10.3 million in 2019.Overall, it was a very successful year for HDI, and I'll now ask Faiz to review our financial results with you in some 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 fourth quarter and full year 2019. Then I'll provide some comments on our financial position and capital allocation plans for 2020. Starting with fourth quarter consolidated revenue, our sales increased 4.7% to $287.8 million. That's a gain of $12.8 million compared to 2018. Acquisitions contributed $16.8 million to our sales results, partially offset by a decrease in organic sales of $3.9 million or 1.4%. Organic sales were negatively impacted by the softer market conditions for hardwood lumber. Our fourth quarter gross profit grew by 10.5% to $52.6 million. That's an improvement of $5 million, and it reflects the increased sales and a higher gross profit margin percentage. At 18.3%, gross margin percentage was a full 100 basis points higher than a year ago. This reflects the reestablishment of our import supply lines as well as gross profit margin contribution from the Pacific Mutual Door operations, which carry a higher gross profit profile relative to the rest of our business.Fourth quarter operating expenses increased by $4.2 million year-over-year to $42.2 million. This was primarily due to the addition of expenses from the 2 new businesses we acquired in 2019 as well as some related transaction costs. As a percentage of sales, expenses were 14.6% as compared to 13.8% in the comparative period. We increased adjusted EBITDA by 20.1% to $19.1 million. The $3.2 million improvement reflects higher gross profit, partially offset by increased operating expenses. And profit grew by 13.4% to $6.6 million, while diluted profit per share improved to $0.31 from $0.27 in the same period last year. Overall, it was a strong end to the year.Turning to the results for the full year ended December 31, 2019. We increased total sales by 3.3% to $1.172 billion, a year-over-year improvement of $37.7 million. This was driven by a combination of acquisitions-based growth, and a positive foreign exchange impact on translation of our U.S. sales to Canadian dollars for reporting purposes.Sales in the U.S. were up by USD 12.5 million or 1.6% year-over-year. And sales in Canada grew by $2.8 million or 2%. Gross profit for the full year increased by 5.3% to $212 million. This reflects higher sales and a stronger gross profit margin percentage of 18.1% as compared to 17.7% last year. And operating expenses increased by $12.8 million, mostly due to the addition of acquired businesses and the impact of a stronger U.S. dollar on translation of U.S. operating expenses. In addition, bad debt expense returned to a more typical level in 2019 after being unusually low the previous year. Adjusted EBITDA of $79 million for the year was up slightly from $78.9 million in 2018. We generated profit per share of $1.38 and adjusted profit per share of $1.49.Looking now at our financial position and capital allocation priorities. Our balance sheet continues to be responsibly managed. As at year-end, our net debt to adjusted EBITDA ratio was a conservative 2x. Our debt-to-capital ratio was just 27%. We also had $69.8 million of unused debt capacity available. We are confident in our ability to manage through short-term disruptions that may be caused by an economic slowdown related to the COVID-19 virus.As we move forward, our capital allocation priorities for 2020 will include maintaining sufficient capital reserves to weather any impacts related to an economic slowdown, executing on our acquisitions pipeline, continuing to return value to shareholders in the form of dividends and share repurchases and ensuring continued responsible management of our balance sheet.Now I'll turn the call back to Rob. Rob?

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

Great. Thanks, Faiz. I'll close today with a few comments on our outlook. As we move into a rapidly changing economic environment, our size, strength and agility will be more important to us than ever. We do not yet know the full impact of the COVID-19 pandemic will be, but we're well prepared to respond to the challenge. Our balance sheet is in excellent shape. We maintain significant financial flexibility. Our business now is larger, stronger and more diverse than ever. And we have a business model that's proved itself through over 60 years of changing economic conditions. As we move forward, we will continue to prioritize the health and safety of our employees and customers, and we will adapt our ways of doing business as required. We will also intend to continue to advance our growth strategy. We've already announced our first acquisition of 2020, which was the purchase of Diamond Hardwoods, this brings us 2 new locations in Northern California with annualized sales of approximately $9 million. Our acquisitions pipeline remains active. And with our strong balance sheet in a highly fragmented industry, we intend to act on opportunities that complement our internal growth strategies. Going forward, we will also continue to focus on capturing market share, leveraging our platform and significant resources to create competitive advantages. And we will further strengthen the business as we enhance and leverage our supply chain and the way that we manage our partnership relationships. We're also employing technology-enabled solutions and optimized strategic human resource capabilities. We're proud of the growth and the shareholder value we achieved in 2019, and we're confident in our ability to continue leading the industry and rewarding investors.With that, I thank you for your attention. I'm going to now turn the call back to Jessica 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, could you give us a sense yet whether you've seen your customers either reducing their own production rates or reducing orders product from you?

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

We have not. So I'm speaking with the benefit of sales runs up until last night. My general statement is, as I made -- said in my opening comments, that activity levels have been good. We've been running as have our customers. The question, I think here is more of forward looking, how does that change. But to this point, we've not seen any meaningful slow out.

[Hamir Patel]

Okay. Great. And then, Rob, realizing the outlook for Q2 and beyond is very uncertain. But for Q1, would you expect to see positive organic growth, or do you still have negative pricing comps for hardwood lumber in the first quarter?

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

Yes, we don't kind of provide forward-looking information in that way, Hamir, unfortunately, as you know, and -- but we've got about 9 selling days left in the quarter. I mean, my comment would be you mentioned the hardwood lumber. The -- that's really stabilized in terms of pricing. But if you look back compared to where it was a year ago, yes, we're still selling a much-diminished product in terms of price. And -- but I would say, might reiterate my comment that through the majority of the first quarter here, and we got a couple of weeks to go, we've seen very good activity levels in our customer base. And if you look at our results from last year, we did have growth in our other product categories. We just had the one headwind, which was the lumber product segment.

[Operator]

Your next question comes from Yuri Lynk with Canaccord Genuity.

[Yuri Lynk]

I guess, Rob, any -- are you noticing any impacts from the COVID-19 on your Asian supply chain? Has production been impacted at all? Or anything you're noticing on that front?

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

So less than you would have probably expected given the coronavirus kind of started out, obviously, in China and then moved a little bit more through Southeast Asia. So not really is the answer. I would say we're seeing some things like Malaysia has now, now has a 2-week shutdown, and we source some product from Malaysia. So we're not going to be getting any for the next -- any new production for the next couple of weeks. But the comment I would make is, we generally keep buffer stock in the warehouses in terms of the levels that we have available to our customers. So a disruption like that is not a material event. For the most part, we've had containers flowing across the ocean and into our warehouses.

[Yuri Lynk]

But should we expect maybe some advanced purchasing on your behalf to kind of build up some inventory in case that situation changes?

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

We actually feel quite good about where our inventory sits today relative to the activity levels we've got. And if there were to be a slowdown, we also think that we're in decent shape to match if there is some reduced demand. So, no, I don't anticipate that we're going to be kind of stocking up, keeping in mind, about 75% of what we source is North American based, not from overseas. And that the overseas portion that we have, we typically carry a little more they might be necessary anyway because it's a longer supply chain, and it's kind of meant to buffer disruptions that might occur for that reason.

[Yuri Lynk]

Okay. Last one from me, just on FX. Obviously, there's been a big downdraft in the Canadian dollar. Faiz, anything I should be watching for in terms of beyond just the straight translation impact? I mean, are there any products in Canada that you sell in USD that might be a lot more expensive now? Does it impact your M&A strategy at all? Just any comments on the big move in the Canadian dollar.

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

Yes. So the quick answer on the M&A impact is it doesn't. For the most part, as I think, Yuri, we tend to keep the cash flows in their home currencies. So a majority of our acquisition opportunities are in the U.S., and we have U.S. cash flows to support that activity. So foreign exchange, I don't expect would impact our acquisitions activity at all. In terms of your comment around what about more cross border, I wouldn't expect that to be significant. Products don't generally travel. The end product doesn't generally travel too much across the board, not significantly. But you are correct in that. The fiber base of many of the products is in the U.S. and that has flown into Canada in terms of what our Canadian business sells. So the impact on the business might be the 10% or consolidated sales that are in Canada and a rising exchange rate or a stronger U.S. dollar would actually -- we would expect benefit the top line sales growth for Canada because it's a price pass-through model. So if the product costs us more to purchase in Canada, then we are going to pass it on to the customer over a relatively short period of time. So given the way the exchange rate is moving, it might be slightly positive. But again, it's 10% of our business. So I wouldn't call that out as material either.

[Operator]

[Operator Instructions] Your next question comes from Zachary Evershed with National Bank Financial.

[Zachary Evershed, Analyst]

So most of the questions, the main ones have already been answered. So I'll just get a little bit more into the weeds here. Saw that days payable ticked up quite a bit to kind of peak levels in the last few years. Anything of note going on there?

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

Yes, Zach. Faiz, I can take that question. So nothing to call out in there. There's some things on timing, and you've also got the payables related to the Pacific Mutual Door and the Far West acquisitions, if you're comparing year-over-year. So you would see that in there as well, but nothing to call out.

[Zachary Evershed, Analyst]

And then, obviously, everything is just conjecture at this point in time. But talking to your customers, is there a kind of broad consensus on the likelihood of the construction shutdown similar to what's happening in Boston?

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

Yes. No, we're familiar with the Boston situation. I wouldn't say there's a consensus. No. People have different opinions. And the reality is that we just had a February with 1.6 million starts in the U.S. Canada was also very strong, both countries up kind of 20% to 30% year-over-year. Single-family starts were strong. Homebuilders are starting to participate in the end of the market where there's the most demand. Interest rates are very low. Conditions are very good. The one exception is what's going on with the coronavirus. So the disruption that may have. And that's anyone's guess, frankly. So what we're doing is just preparing our business really for all possible scenarios. And if there is a pause here, we're going to be ready to be -- come up very strongly on the other side to take advantage of that.

[Zachary Evershed, Analyst]

Then one last one from me. In the event that there is a broader shutdown of construction activity. Would you consider putting the dividend on hold? Or do you think you have sufficient capital reserves to continue funding that?

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

No, we feel good about the dividend, Zach. As I mentioned, we have significant capital reserves. We're very well capitalized. We're not carrying any term debt, high-quality assets in the balance sheet. I think in the instance of kind of a rude and fast-changing economic environment like we saw in 2008, maybe it's our best case study, our business performed very well from a cash perspective at that time. And because of the self-liquidating nature of our balance sheet, we can bring down inventories, we can collect receivables and we can liberate working capital that's in the balance sheet. So no, we feel fine and comfortable about the dividend at this point for sure.

[Operator]

There are no further questions at this time. Please proceed.

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

Okay. Thanks, Jessica, and thanks, everybody, for joining us for the call today. Appreciate your interest and questions. Please do reach out to Faiz and I if you've got follow-ups, and we'll be pleased to chat with 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.