Hardwoods Distribution Inc

TSX:HDI

Earnings Call Transcript 2021-Q4

[Operator]

Good day, and welcome to HDI's Fourth Quarter and Year-end 2021 Results Conference Call. Today's call is being recorded.

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

[Ian Tharp, executive]

Thank you, Katie, and good morning to those joining today as we discuss HDI's financial results for the fourth quarter and full year 2021. My name is Ian Tharp, Investor Relations for HDI. And joining me on the call today are: Rob Brown, HDI's President and Chief Executive Officer; and Faiz Karmally, Vice President and Chief Financial Officer.

HDI's Q4 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 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 U.S. dollars, unless stated otherwise. I'd like to now turn the call over to Rob Brown. Rob?

[Robert Brown, executive]

Thanks, Ian, and good morning, everyone. I'm pleased to chat with you today as we report record-setting results for 2021. I'll start today with our key financial and business highlights for the year. Our CFO, Faiz Karmally, will then provide details of our Q4 financial results. I'll finish off today's prepared remarks with our outlook for 2022.

2021 was a remarkable year for HDI. Our record growth and outstanding financial performance during the year underscores the magnitude and the success of the transformation we've achieved in our business. Financially, we realized a significant milestone as total sales rose to a record $1.6 billion, which was 74% higher than the sales we generated in 2020. It also surpasses our previously stated goal of achieving sales of CAD 1.5 billion by 2023, which we reached 2 years ahead of schedule.

Our bottom line results more than kept pace with our top line growth. Adjusted EBITDA for 2021 gone to 168% to $195.2 million and profit per share grew 265% to $4.81, setting an all-time profitability record for the company. Those are outstanding achievements and I want to thank every member of the HDI team for their contributions to our results. We've realized our goal of transforming HDI into a leading supplier of architectural building products that help our customers create beautiful finished spaces where we live, work and play.

To speak more about HDI's transformation, I'll contrast it to just 6 years ago. At that time, our business was roughly 1/4 of the size it is today. We operated from 33 locations. The customers we served were primarily industrial customers and we generated annual sales of roughly $450 million across 2 product groups, hardwood lumber and hardwood plywood.

HDI in 2016 was successful, however, we saw new opportunities to leverage our distribution and our product sourcing strengths to expand into higher-margin architectural product offerings and to access a larger and more diverse customer base. Through our strategic focus on acquisitions, since 2016, we've successfully completed a total of 11 acquisitions. We closed our purchase of Novo Building Products, which was our largest acquisition to date in July of 2021. Novo brought us over $670 million in pro forma annual sales and over $60 million in pro forma annual EBITDA. Importantly, it held a key strategic goal by giving us turnkey access to 2 large and very attractive new customer channels, DIY and home builder sales that go through home centers and pro dealers. With this access, we more than doubled HDI's addressable market.

And we've continued to execute on our business strategies since acquiring Novo. In December, we completed a successful CAD $100 million equity offering, which helped us finance our follow-on acquisition of Mid-Am Building Products, which we then closed in February of 2022. Mid-Am builds geographically on our acquisition of Novo by further expanding our reach into the pro dealer channels in the U.S. Midwest. It also brought us another $270 million of pro forma annual sales and attractive EBITDA margins. Our targeted and accretive acquisitions, plus our own organic growth strategies have transformed HDI. Our distribution network has grown from 33 to 86 facilities today and U.S. sales now represent 90% of total sales as compared to 70% in 2016.

Our diversification has increased with over 75,000 customers now served through a more diverse set of customer channels, including industrial manufacturers, pro dealers and home centers. Our product mix has evolved to include higher-margin specialty architectural products. We now sell across 8 broad product categories with no single product category representing more than 20% of our pro forma sales.

And we're generating exceptional financial results. Annual sales climbed from roughly $450 million in 2016 and to $1.6 billion in 2021, and pro forma annual sales would have been over $2.2 billion with the addition of Novo and Mid-Am.

Our enhanced product mix has supported a significant improvement in our gross margin percentage, and our profit per share has increased from 2016 to 2021 at a compounded annual growth rate of over 37%.

From a market perspective, in 2021, our team capitalized on a strong market environment. Our supply chain, which we view as a major competitive advantage, played a significant role by enabling us to access product in very tight supply conditions and respond to strong market demand. This, in turn, contributed to higher volumes and increased market prices for our products. Our operating performance in this environment has been exceptional as well and was a contributing factor leading to the increase in gross margin percentage year-on-year of almost 400 basis points. Operating expenses were well controlled across the organization with expenses as a percentage of sales decreasing year-over-year.

The record performance in 2021 was the result of a combination of our strengths: an accretive and scale transaction, the resilience of our supply chain, the ability to leverage scale, a prudent business model and very tight operational management. This performance translated into very good returns for shareholders. HDI's total shareholder return in 2021 was 79%, outpacing the TSX Index. It was an exceptional 2021 for HDI, and our outlook is also very positive.

I'll return later to speak about that in more detail, but now I'll pass the call to Faiz to review the Q4 financial results in more detail. Faiz?

[Faiz Karmally, executive]

Thanks, Rob, and good morning, everyone. I'm going to recap our financial results for the fourth quarter of 2021. I'll also outline our financial position at year-end. Again, I'll remind those listening that any dollar figures Rob and I use today are in U.S. dollars, unless we've stated otherwise.

Starting with consolidated revenue. We generated very strong sales of $515.4 million in Q4, which was an increase of 118% or $278.8 million from Q4 in 2020. Organic sales were strong and accounted for $95.5 million or 40.4% of the sales growth, and acquired businesses contributed $188.6 million or 79.8% of the increase in sales. Our Novo acquisition accounted for $169.2 million of the increased sales in Q4.

In our U.S. operations, Q4 sales were $470.7 million, which was a 128% increase over the corresponding quarter in 2020. U.S.-based sales increased by $264.4 million with organic sales growth accounting for $82.6 million or 40% of the sales growth and applied businesses accounted for $188.6 million of the total sales growth.

Our Canadian operations were also strong contributors to our Q4 results. Q4 sales in Canada rose by $668.8 million, which was 42.7% gain compared to Q4 in 2020 and was entirely driven by organic growth. Our success in delivering strong growth in our organic sales was supported by robust market demand, which drove higher unit volumes as well as higher product prices.

Turning to gross profit. This declined to 171% to $122.9 million in the fourth quarter. This significant increase reflects our strong sales results, the addition of Novo and a strong gross profit margin percentage of 23.8%. This continued gross margin percentage strength reflects a number of factors, including favorable market dynamics, changes in product mix and the inclusion of the Novo business, which carries a slightly higher gross margin percentage.

Our operating expenses for Q4 were $76.4 million or $40.8 million higher than the fourth quarter of 2020. The primary drivers of the increase related to acquired businesses and investments in the business to support our growth, which accounted for $34.3 million and $6.3 million of the increase, respectively.

Looking at our operating expenses as a percentage of sales, it decreased to 14.8% in the fourth quarter of 2021 as compared to 15% in the fourth quarter last year. This reflects our focus on expense management throughout the business.

Moving now to adjusted EBITDA. For Q4 2021, it declined 232% year-over-year to $61.7 million. As a percentage of sales, our adjusted EBITDA margin was 12% for Q4, which was a substantial improvement on the 7.9% adjusted EBITDA margin posted for Q4 of 2020.

As a positive indicator of the operating leverage we're capturing as our business expands, Q4 profit grew at an even faster pace. Q4 profit of $32.1 million represented a 452% of year-over-year growth rate as compared to the same period in the prior year. On a per share basis, profit climbed to $1.47, an increase of 425% on over the $0.28 per share in Q4 of 2020.

Turning now to our value. We ended the fourth quarter in good financial position with a leverage ratio of 2.4x. As you know, following year-end, we've made further announcements that impact our capital structure. Along with our acquisition of Mid-Am Building Products, which closed in early February, we announced an upsizing of our existing credit facility to $900 million.

We're focused on the efficient use of our capital structure and our ability to support new growth initiatives that create further value for shareholders remains strong. Our 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.

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

[Robert Brown, executive]

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 in the U.S., which accounts for approximately 90% of our sales. The outlook for residential and repair and remodel construction remains highly positive. We continue to see a multiyear runway for growth driven by some important factors.

For new homes, positive factors include housing starts remain elevated after meaningfully lagging population growth for a decade. Millennials, which are the largest segment of the population, are entering their peak home-buying years, and mortgage rates and home equity levels support further investment in new homes.

For the R&R market, positive factors include U.S. housing stock continues to age, and it's in need of either a refurbishment or replacement. Home equity levels are rising and lower-cost consumer capital is available and individuals are spending more time in and disposable income on their homes. These trends are supportive of a multiyear period of demand for our products.

For commercial markets in the U.S., the outlook is more mixed. Our participation in the commercial markets is highly diverse, however, and it includes construction activity in health care, education, public buildings, hospitality, office, retail facilities and recreational vehicles. The very broad nature of our involvement in the commercial market by both geography and end use has generally resulted in stable performance within this segment.

On the supply front, we expect continued tightness, however, we are often the largest customer for our suppliers and generally expect to have access to product. In addition, we believe that our global supply chain is best-in-class and should provide additional supply options for us, as it did in 2021.

We do acknowledge that the availability and predictability of freight in the market was disrupted in 2021 and this is expected to continue into 2022. As a significant importer, we believe we're well positioned to access multiple freight options. We have dedicated internal resources that manage our freight logistics daily and our strong balance sheet allows us to invest working capital to secure product and freight solutions that help us meet the needs of our customers. In 2021, we did not experience significant adverse effects from global freight challenges, which we believe shows the resilience of our business.

I want to wrap up my comments today by highlighting the growth and profitability our team has continued to deliver. Importantly, we've achieved through these results on an accretive basis and generated strong returns for shareholders. We continue to see new avenues to gain market share with organic growth options across our expanded business base and also through future acquisitions. We've proven our ability to successfully secure and integrate acquisitions, and our industry holds further potential on the M&A front. We maintain a capital -- or a flexible capital structure and have capacity to execute on our growth strategies going forward.

At the close of this exceptional 2021 year, I'm deeply proud of the transformation HDI has achieved and very excited about what we will do with our increased size, strength and opportunities in 2022.

With that, I want to thank you for your time this morning. I would ask our operator, Katie, to please provide instructions for the Q&A period. Katie?

[Operator]

[Operator Instructions] We'll take our first question from Hamir Patel with CIBC Capital Markets.

[Hamir Patel, analyst]

Rob, I wanted to ask you about what the potential impact of the war in Ukraine could be? I believe Russia might be sort of 10% of the U.S. hardwood-plywood market. So what impact do you expect that to have on your import strategy and product prices in the U.S. market?

[Robert Brown, executive]

Yes. Hamir, that 10% number, yes, we're familiar with that. I've seen some numbers a little bit higher and a little bit lower than that, but I think that's a reasonable starting place.

So for our business, we do a little bit of product out of Russia. We suspended all sourcing of that product once the conflict began. So we're currently on permanent suspension with Russia. This is not a material amount of volume for our company, and we believe we've got other sourcing solutions that we'll be able to bring to customers in terms of a solution for them to move off of that previous product offering that might have been available from that country, from us and others.

[Hamir Patel, analyst]

Great. That's helpful. And just, I know there's been a lot of different price increases across the building product space, but for some of your product categories, I'm seeing doors and stair parts where we don't have as much visibility, what kind of annual pricing comps are you seeing in the market today in Q1?

[Robert Brown, executive]

Yes. I think that the comment I would make in the market in 2022 is, while we saw significant increases in 2021, we're not seeing the same again in 2022 so much as a holding pattern. So prices aren't particularly slipping or rising, but more holding firm would be the overall theme I would give you for what we've seen so far for this year.

[Operator]

[Operator Instructions] We'll go next to Zachary Evershed with National Bank Financial.

[Zachary Evershed, analyst]

Congrats on the quarter. So working capital investments are ramping up the volumes and pricing you're seeing, a 2-parter for you on inventories. Number one, are you fully prepared for another strong year? Or are you still pushing to build up stock in some product lines? And then second part, if the bottom does fall out in residential, how quickly can you reverse direction and rightsize your inventory position?

[Faiz Karmally, executive]

Yes. Zach, it's Faiz here. I can take those questions. So I think there's a couple of questions in there. I'll try to hit them all. You tell me if I missed one. But in terms of the working capital, I would say to just -- you're focusing on inventory, which is correct. The receivable balance is up, but just for completeness, I thought I'd mention, if you look at that on a turns basis, it's actually performing great. So it's not that it's because we're just selling a lot more.

So if we just maybe focus more on the inventory piece of your question and we look at the balance, it's higher, but most of that is in the in-transit pipeline. So when we look at the inventory just on our floor, that's very well positioned. And then if you look at where some of the what might be considered excess when you look at the financial statements, it's really in the in-transit pipeline.

The in-transit is larger for a couple of reasons. One, that product, the costs were rising towards the end of last year, and so it's just worth more. Similar comment on freight costs. Those would be higher, as we know, last year, building up last year and so that's in there as well. And we've also had to do some maneuvering in terms of just managing what are disrupted and type supply chains, which the entire globe is facing today. So there's a little bit more on the water, there's a little bit more in warehouses before it gets to our warehouse, et cetera, et cetera.

And just how we position heading into 2022? I think we're positioned really well. As I mentioned, we've got the stock that I think we need on the floor today. I wouldn't point at something and say there's a big gap in inventory, where we're trying to sell at this very moment.

And I think that import supply that's coming, yes, it's a bit of a glut in the supply chain there, but it's going to serve us really well as we work through the year here in the first couple of quarters, having that supply. I think it's going to serve us really, really well because as Rob mentioned, our customers are still busy and demand is still very strong. So that inventory is all going to result in some very good sales for us in the next couple of quarters.

To your last question around what if the bottom falls out of residential housing? I guess I would just say the obvious statement here and that is not really one of our planning assumptions for 2022, I mean, for all the reasons. Rob mentioned the macro environment is extremely supportive and we're not really seeing any signs of that that's slowing down. In terms of how we manage the balance sheet in a downturn. I think we saw that. We saw that in COVID when it hit, I guess, 2 years ago this month, where I guess the bottom did fall and we lost 20% of our sales in a matter of week. So we were able to really work down working capital in a quarter. And so we would enact those same procedures if that were to happen again. But as I said, it's really not something we think is a likely scenario in 2022.

[Zachary Evershed, analyst]

I agree with you there. And that was a great color. And then just maybe a follow-up on the freight disruptions you mentioned. What's your view on those improving as we move through the year? And will pricing and margins peel back significantly when that does improve?

[Robert Brown, executive]

Yes. I would describe that also as more stable. Some people have described a modest improving. We've seen, it's not just about freight, it's a pipe, right? It needs to get across oceans that needs to be sufficient machinery to unload freight, capacity adoption and warehouses to put it in, and then trucks to bring it in from an inland freight perspective. So it's not one thing. You have to look at it in its totality.

We've again done quite well just because of our size in terms of being able to get access to those resources I just described. But at this point, I don't see, Zach, kind of a lessening or loosening up of that in the intermediate term.

[Zachary Evershed, analyst]

And -- but once we do see that kind of loosening, what's your view on the impact on your organic growth and your margins?

[Robert Brown, executive]

Well, I mean, the impact is the same as we've seen on -- in a tightening if you have a loosening, which again is what we're seeing, you would have the freight as a component of the total product price would begin to fall. And with that, you would have prices that would also come off as well. So you would have price deflation against the significant price inflation that we've really seen through 2021. But just to reiterate, we're not kind of seeing that on the dashboard at this time. But at some point down the road, when that happens, that would be -- how that would work its way through the system.

[Operator]

We'll take our next question from Yuri Lynk with Canaccord Genuity.

[Yuri Lynk, analyst]

Rob, very positive outlook, obviously, as you've outlined. When we think about next year, I'll ask maybe a different question. What are some of the headwinds that you see to growing EBITDA and EPS on 2021? I mean, your EBITDA margin, as you highlighted, I mean, it's almost doubled from pre-pandemic levels, 35% organic growth last year. I mean these are extraordinary numbers. And just wondering if -- what sort of the headwinds, if any, there might be to repeating some of that performance or sustaining it?

[Robert Brown, executive]

Yes. Yes, for sure. That's a very fair question. I think maybe the first thing I'd just point out is you've also got acquisitions growth that's riding on-site or besides the organic growth. So even if the organic environment is softer at some point, we've had good acquisitions along the way and we expect to continue to do that.

In terms of headwinds against EBITDA and EPS growth, in 2022, this still looks like a very positive environment. So I guess I would also make the observation, maybe those headwinds are further ways out. But I still want to answer your question, which is, to me, it's not -- it's relatively connected to the question that Zach just asked. At some point, if you've got deflation in pricing of building products generally because they all have had a very nice step change, as we know, and that may be in the basic product availability becomes more widely available and prices, therefore, softer and/or at the same time, freight, which is a component of moving product around, becomes easier to get at.

Both those things with price deflation would have an impact on that bottom line EPS and EBITDA because you'd be pushing through -- it's -- so we're pushing through very good volumes, but you'd be doing it with lower cost of goods, which would then carry with it lower gross profit dollars on an absolute basis. So I'd maybe point that one out.

The other one that's worth commenting on, Yuri, would just be operating costs. We've done real well on operating costs. And I would say, if you look at our costs, the biggest one is our people that we employ and how we pay our teammates. We've had people who participate on the sales side have done very well in this environment, as you'd expect through commission-based pay. And if we do have a downside where things start to move the other way, there's a natural kind of adjuster there in terms of those costs moving with what's going on with overall sales and gross profit margin dollars. But yes, otherwise, I think those would probably be the 2 that I would highlight. There's always the macro view just around inflation and interest rate environment.

We've looked very hard at that and we actually feel quite comfortable with the path that the Fed is on and where we think it takes us over the next 7 open market meetings that are scheduled for this year anyway, it still remains at levels that are going to support good demand for our products.

[Yuri Lynk, analyst]

Okay. Helpful. Maybe just on capital allocation. I mean, your stock has done extremely well. But nevertheless, it's pretty cheap, very cheap. And depending on the numbers you look at, I think it's trading below the multiple that you would have -- how do we -- does that stop you from doing M&A? Do you want a better multiple before you do another deal? Do you want to delever a little bit here before you do another deal? Are buybacks on the table? Just how you think about your M&A in the context of your tenant valuation?

[Faiz Karmally, executive]

Yuri, it's Faiz here. I can take that one. So my comments there would be, just from a balance sheet perspective, and do you want to delever before the next acquisition? I mean that's going to happen naturally. If we don't do an acquisition, as you know, significant free cash flow will be generated this year. And that's where some of it will go. But I would say we're not paused like the balance sheet with a pro forma leverage post Mid-Am we talked about it being around 3, that's comfortable. So we're still looking at things on an acquisition pipeline today.

In terms of just capital allocation, I mean, our focus is really on growth, supporting organic growth like we did last year, which can require, I'll say, opportunistic working capital investments, which served us really well last year, and I think it will serve us again well in 2022. I mentioned acquisitions as well. So that's really our primary focus of capital.

We have the dividend, which we just increased, that is the NCIB, which your comments were taken, and I agree with what you said in terms of value, and we'll continue to look at that as a placement of capital as we move through the year in 2022.

[Robert Brown, executive]

I got to jump in there for a second as well. Thanks, Faiz. Your comment on the attractive price, I agree wholeheartedly with that. I mean this is still -- we've had significant returns on price appreciation. This is still an excellent entry point for new shareholders or existing to invest for in the company. We tried to outline, hopefully, you're listening upfront. I know some of these calls get a little tedious with the opening comments. But just with the transformation and diversification of the company across the macro environment we see is extremely positive and the way the company has performed operationally to produce results and then you layer on to that, the expanded addressable market that we've now creative through our acquisitions program and then we think we have a much broader set of acquisition opportunities going forward.

So I think all that's very positive. And we've clicked over that $1 billion market cap number, and we've got our eye here in the future, hopefully on joining the TSX index. So I think there's just lots of very good things in terms of future potential momentum for the stock hearing.

[Operator]

We'll take a follow-up from Zachary Evershed with National Bank Financial.

[Zachary Evershed, analyst]

So interesting follow-up on the broader set of acquisition opportunities you mentioned. Given how rapidly you've grown the business, are you receiving inbound calls from potential targets that are maybe outside of your wheelhouse product-wise or geographically?

[Robert Brown, executive]

Yes, we're getting lots of opportunities come across our desk from an acquisitions perspective, Zach. The Novo deal plus the Mid-Am deal were both chunky deals, and that put us on some new lists, I would say, in terms of U.S. mid-market banking communities. So the answer is yes.

I'd say we always go back to that kind of grounding statement that HDI is looking to be a world-class distributor of architectural building products. So we run it through that lens. It's a fairly broad lens, which allowed us to evaluate both Novo and Mid-Am and come to a determination of that was creative for the company. And there are other things that are coming through the front door like that, that we are considering. Anything that we do, do, though, is going to be strategic. So we're not -- it's not growth for growth sake. We're trying to build something special within the industry here and feel like we've got a good momentum in doing that.

[Zachary Evershed, analyst]

That's helpful. And then the last one for me. Could you give us a bit more color on where you're seeing strength and weakness in your commercial end markets, please?

[Robert Brown, executive]

Yes, nothing probably new there, Zach, from what we've said in the past. But I would say we've seen because there's been lots going on in health care, obviously, that has been a sector where our fabricator customers have had greater activity in recent times. Public buildings is a little bit of a wait-and-see as it relates to infrastructure build in the U.S. and whether there's some knock-on effects from government spending in that area. We're seeing a little bit more strength in hospitality. Recreational vehicle has been very strong for us for the last couple of years and then finishing surfaces and millwork around things like industrial data centers has obviously been a source of strength for some time.

[Zachary Evershed, analyst]

That's great. Congrats on the quarter again.

[Robert Brown, executive]

You bet.

[Operator]

At this time, there are no additional questions in queue. I'd like to turn the call back over to our speakers for any additional or closing remarks.

[Robert Brown, executive]

Okay. Yes. Thanks, everyone, on the line for joining us. I appreciate your interest as always, and to reach out to Faiz, myself or Ian, if you've got questions or follow-up comments, and have a great day.

[Operator]

Thank you. That will conclude today's call. We appreciate your participation.