Hardwoods Distribution Inc

TSX:HDI

Earnings Call Transcript 2022-Q4

[Operator]

Good day, ladies and gentlemen, and welcome to the ADENTRA's Fourth Quarter and Year-End 2022 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 Monday, March 13, 2023.

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

[Ian Tharp, IR]

Thanks, Michelle, and good morning to everyone on the line as we discuss ADENTRA's financial results for the fourth quarter and year ended 2022. My name is Ian Tharp, Investor Relations for ADENTRA, and joining me on the call today are Rob Brown, ADENTRA's President and Chief Executive Officer; and Faiz Karmally, Vice President and Chief Financial Officer.

ADENTRA's Q4 and year end 2022 earnings release, financial statements, MD&A, and other disclosures are available on the Investors section of ADENTRA's website at www.adentragroup.com. These statements have also been filed on ADENTRA's profile on SEDAR at www.sedar.com.

Before we begin today, I want to remind listeners that during today's 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 ADENTRA's earnings press release and financial filings issued today for a discussion of the risks and uncertainties associated with these forward-looking statements. All our 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?

[Robert Brown, President & CEO]

Thanks, Ian. Good morning, everyone. I am pleased to speak with you this morning as we report a strong year of financial and operating performance for ADENTRA in 2022. I'll start today with our key financial and business highlights for the year. Faiz Karmally, our CFO, will then provide details of our Q4 financial results. I'll then finish off today's prepared remarks with our outlook for 2023.

Starting with 2022 financial highlights, 2022 was an exceptional year for ADENTRA, we successfully demonstrated the strategic value of our business model and delivered another year of record financial results. Financially, we achieved new milestone with total annual sales of $2.6 billion, which was 59% higher than the record sales we generated in 2021.

Notably, these results were achieved through both strong organic sales growth and through our acquisitions of the Novo and Mid-Am businesses, which brought us significant new size and strength. As we have expanded our operating platform, we've taking care to maintain tight controls on our expenses. Our gross margin percentage in 2022 remained strong at 21.6% and despite the inflationary pressures experienced throughout our business during the year, our operating expenses at 14% of sales were well managed.

Our strong operational performance ensured the record sales led to year-over-year earnings growth with adjusted EBITDA for 2022 reaching a new high of $267.9 million, an increase of 37% over 2021. Profit per share grew 14% to $5.50 surpassing our previous profit record set in 2021. Importantly, the earnings translated to strong cash flows. Our cash flows from operating activities for the year was $210.7 million and includes a $28 million reduction in working capital, even after growing sales organically by over 14%.

We deployed this cash effectively with the purchase of Mid-Am, repurchasing over 5% of the issued and outstanding shares, and announcing in the fall an 8% increase in the quarterly dividend. These are excellent results, I want to thank the entire ADENTRA team for their dedication, which drove this performance.

Since our Q3 results call in November, we have completed another strategic step in the evolution of our business with the re-branding of our company as ADENTRA. This rebranding, which was completed in early December involve a change of our ticker symbol to ADEN on the TSX, and the launch of a new corporate and investor website at www.adentragroup.com. We believe the ADENTRA name is an excellent reflection of the company today, as one of North America's largest diversified distributors of architectural building products.

Concurrent with the rebrand we held our first Analyst Day where ADENTRA's leadership team unveiled our strategic priorities and plans to continue creating shareholder value. These priorities included our Destination 2026 goal of $3.5 billion in run rate sales by 2026, and our continued focus on digital engagement with our customers.

As we've advanced into 2023, we've also -- we're also excited to establish new transparency into our operations and management practices through the issuance of our first sustainability report. The sustainability report is grounded in our core values, integrity, fairness, people and passion. It outlines key focus areas consistent within the industry and specific to our business and how we are aligning our sustainability efforts with our continued pursuit of financial performance.

I'll return to speak more about 2023 and our outlook later on. And I will now pass the call to Faiz to review our Q4 financial results in some more detail. Faiz?

[Faiz Karmally, VP & CFO]

Thanks, Rob and good morning, everyone. I'm going to recap our financial results for the fourth quarter of 2022, and outline our financial position at year end. Again, I'll remind those listening that any dollar figures Rob and I used today are in U.S. dollars, unless we've stated otherwise.

Starting with consolidated revenue, we generated sales of $574.7 million in Q4, which was an increase of 11.5% or $59.4 million over the fourth quarter of 2021. Acquired businesses contributed $68.5 million increase in Q4 sales, while organic sales decreased by $5.9 million, reflecting lower volumes, partially offset by higher selling prices.

Also partially offsetting the gains in sales in Q4 was at $3.2 million unfavorable FX impact due to the translation of our Canadian sales into U.S. dollars for reporting purposes. Sales in our U.S. operations were $533.2 million, which was 13.3% higher than the corresponding quarter in 2021. Our acquisition of Mid-Am accounted for $68.5 million in increased U.S. sales and this was partially offset by a $6 million or 1.3% decrease in organic sales due to the reasons I mentioned earlier.

Our Canadian operations posted a slight increase in Q4 sales to CAD57 million, which was a 1.3% increase over [Technical Difficulty] in 2021. The increase was entirely organic and reflected higher selling prices, offset by a modest decrease in volumes.

Turning to gross profit. We earned $116.2 million in the fourth quarter, a 5.5% decrease as compared to Q4 in 2021. This change reflects lower organic sales and reduced gross profit percentage of 20.2%. During Q4, we recorded a total of $7.6 million in inventory write-downs, a higher than normal amount as we worked to normalize inventory levels by year's end.

If we exclude the impacts of these write-downs, our gross profit percentage would have been 21.5% as compared to 24.1% in Q4 of 2021. We expected that the unusually high gross margin percentage performance in Q4 of 2021 will not repeat, as it reflected favorable market dynamics, including strong demand and tight supply, which resulted in a rapid increase in product prices in that period.

Our operating expenses for Q4 were $91.6 million, or $15.1 million higher than Q4 of 2021, a total of $11.3 million of this increase related to incremental operating expenses and intangible asset amortization from acquired businesses and investments in our business to support organic growth accounted for $3.9 million of the year-over-year increase.

Moving now to adjusted EBITDA. For Q4 2022 it was $43.6 million. a decline of 29.3% that was driven by the expected decrease in Q4 gross profit margin levels and the increase in operating expenses as described. As a percentage of sales, our adjusted EBITDA margin was 7.6% for Q4 of 2022 as compared to 12% in Q4 of 2021.

Finally, Q4 profit was $13.4 million because of the decline of $18.8 million from the same period in the prior year. This change was driven by the reduced EBITDA mentioned earlier, increase in depreciation and amortization of $4.4 million, and $9.7 million in additional finance expenses offset by a $12.9 million decrease in income tax expense.

On a per share basis, profit was $0.59 as compared to $1.47 in Q4 of 2021. Looking at our cash flow position for the quarter, we generated $127.2 million of cash flows from operating activities, a total of $81.8 million was generated from the significant reduction in our inventory levels in the fourth quarter.

Moving next to our balance sheet. Our strong cash flow generation in the fourth quarter enabled us to reduce debt by a total of $108 million. We ended the year in solid financial position with a leverage ratio of 2.4 times and unused borrowing capacity of over $250 million, which gives us the flexibility necessary to manage any short-term headwinds, fund future growth and continue to advance our business strategies.

Our capital allocation priorities are the continued responsible management of our balance sheet, funding our organic, as well as acquisitions based growth, and providing incremental total returns to shareholders. In February of 2023, we completed a small tuck-in acquisition in Texas, as part of our ongoing M&A efforts. With respect to returns to shareholders, as Rob referenced earlier through a combination of dividends paid and share repurchases, we returned a total of $36 million to shareholders in 2022.

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

[Robert Brown, President & CEO]

Thanks, Faiz. I'll finish our prepared remarks today with our views on end markets and comments on our strategy to continue building the long-term value of ADENTRA. In the near-term rising inflation and interest rate hikes are expected to have a negative impact on economic activity. We anticipate that this will result in a moderation of demand for our products, and could lead to softer product pricing and volumes as compared to our recent trend.

We are seeing this to start 2023, where our sales pace in January and February is similar to what we experienced in the fourth quarter of 2022. We expect our financial performance to be reduced in 2023, as compared to the record setting levels achieved in 2022. We are confident that our business is positioned to weather the challenging market conditions expected in 2023. We've significantly grown and broadened our end market participation, to include customers in the residential construction, repair and remodel, and commercial sectors.

Channels to market has 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. We've worked to build our scale platform within our industry with 87 locations across North America.

We believe our size, combined with our broad end market participation, expanded channels to market and diverse product mix provides stability, while reducing our exposure to any one geography or segment of the economy. In addition, we maintain a strong balance sheet and over $250 million of undrawn liquidity on our credit facilities. Our business model converts a high proportion of EBITDA to operating cash flow, before changes in working capital.

And in periods of reduced economic activity, we released working capital, resulting in an additional source of cash. This attribute of our business was evident in 2022 when despite slower activity levels in the latter half of the year, we generated substantial operating cash flows of $127 million in the fourth quarter alone. Over the longer term, we expect demand for our products to remain robust supported by strong fundamentals in the residential, repair and remodel, and commercial 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 past decade, and positive demographic factors driving demand for living spaces. In addition, our addressable market is significant at $43 billion and we estimate our current market share at 6% from a market opportunity perspective the expanded platform presents strong new growth prospects and we see substantial potential to expand our market share.

At our Analyst Day in December 2022, ADENTRA's leadership team unveiled the strategic priorities for our business, including our Destination 2026 goal of $3.5 billion in run rate sales by 2026. Those materials can be found on the ADENTRA website.

With that, I want to thank you for your time this morning. I'm sure there is questions. So I'll turn it back to Michelle to provide instructions for the Q&A period. Michelle?

[Operator]

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] First question comes from Hamir Patel of CIBC Capital Markets. Please go ahead.

[Hamir Patel, CIBC Capital Markets]

Hi. Good morning. Rob -- $8 million of inventory write-downs in the quarter, was that kind of across the board or was it driven by weakness in certain product categories and how should we think about the risk of further write-downs over the balance of the year?

[Robert Brown, President & CEO]

I think we've done a very good job getting the inventory into what I would call quite good shape at this point in the cycle. We indicated coming out of Q3, that we had more to do on the inventory. The $8 million, I mean on a normal quarter, we would typically write-off to. So, you can kind of take that delta of $5 million or $6 million incremental that we took in the fourth quarter as above the average and I don't expect that will continue to run at that, that type of rate.

[Hamir Patel, CIBC Capital Markets]

Okay. Great. And Rob, we hope you maybe give us some color on how product price comps are faring across the different categories.

[Robert Brown, President & CEO]

Yeah. So I probably won't go category-by-category that's a lot. I think we'll lose the crowd. But I would say that into January and February, we've seen volumes pick up relative to where we were in December. The fourth quarter really, the story was December, which was a weaker month. Heading into 2023, we've bounced off that in January and February in terms of volumes. But we've seen product prices continued to soften. We're talking low-single digit on that as an overall perspective, Hamir. So it's orderly, there's not big chunks, but we've continued to see some retraction in overall average prices.

[Hamir Patel, CIBC Capital Markets]

Okay. Great. Thanks, Rob. And just the final question I had for Faiz. With respect to the hardwood plywood case, if commerce's final determination at the end of the month shows no change, would you have to make that sort of $55 million, $60 million duty payment in the second quarter?

[Faiz Karmally, VP & CFO]

Hey, Hamir. Yeah. I think there is, what I would say is, if there is a final determination at the end of March that required some duty payments. We would like PBN to accruing it. In terms of payment, there is a couple of different layers to work through there, you may have to cut the check right away or you may depending on advice we get from legal counsel around that, but I think we would be able to accruing it in Q2, that was the final determination that there were some duties owed.

I would note, on the final determination, just as a point, Hamir, this is not the first time that they put out a deadline and then chose to delay it. So we're going to do a number of iterations now on timelines. The current timeline is we're expecting a final determination at the end of March, but they have moved that previously and they may do so again. So we're watching that, as you would expect, but that's our best information today.

[Robert Brown, President & CEO]

I've just threw in a couple of extra comments on that one as well. You mentioned $55 million to $60 million. We've provided a range in the financial statement disclosure. So there is a lower end of that range as well, you're kind of noted the high end. So I just think that's worth pointing out. And I would just reinforce that if things do roll out that way, we still vehemently disagree and would pursue all angles on appeal. We feel very strong, we've got good documentation that can support that our products should not be included in this ruling, but that would be a fight that would take some time looking at it.

[Hamir Patel, CIBC Capital Markets]

Fair enough. Thanks. That's all I had. I'll turn it over.

[Operator]

Thank you. The next question comes from Yuri Lynk of Canaccord. Please go ahead.

[Yuri Lynk, Canaccord Genuity]

Hey. Good morning, guys.

[Robert Brown, President & CEO]

Hi, Yuri.

[Yuri Lynk, Canaccord Genuity]

Rob, I want to make sure I understand the sales pace that you talked about in January and February being similar to Q4. Does that -- are you saying there that the absolute dollar value of sales is similar to Q4, so Q1 sales-wise is looking pretty similar to Q4 or -- and that's what I think you mean, but are you -- maybe organic growth being similar to Q4, I just want to make sure what exactly you're referencing.

[Robert Brown, President & CEO]

No. Yeah. That's a good question. It would be the former, I mean, the way that we think about it is we track sales every day, so when we look at the fourth quarter as a whole and there's whatever 60, 63 sales days in there, you get a -- you end up with a daily sales pace comparing that daily sales pace to what we saw in January, plus February, they were about of flat about the same.

[Yuri Lynk, Canaccord Genuity]

Okay. Just want to make sure, that's helpful. Second one from me, just on two, I guess related questions on selling, distribution, and admin expenses, the first would just be -- maybe walk us through some of the aspects of those expenses that you can flex as sales come down in '23, like, how much of that can you offset? And just a second question probably for Faiz would be, was there some reclassification between admin and selling and distribution in the quarter? It looks like $10 million one-from-one to the other, I'm not sure.

[Faiz Karmally, VP & CFO]

Yeah. Hi, Yuri. Your first question in terms of variability to expenses or maybe just speak about total expenses. I mean there is some variable components in both those lines, but at a high level about 70% of our expenses related people or premises costs. So rents, overheads associated with your consists etcetera. So in the short-term, there is, I would say limited flex to that on the people side of it some of the compensation base is of course variable. So that would just change with sales, but it's a smaller portion of the total wages and salaries and benefits relative to the total people costs.

So there is some flex in there, but I would say majority of that is a little more semi-fixed. You can do things with that over a couple of quarters, but not necessarily quarter-to-quarter with the exception of the commissions that I noted. The other 30% of costs, Yuri would be a combination of fixed and variable, you're going to have things like professional fees, insurance costs, variable and fixed, you're going to have things like that.

Travel, marketing expenses, trade shows, those are going to be a lot more variable. So there's a bit of a mix of maybe fixed and what I'd like to describe semi-fixed, again on some of those things you can do things over several quarters, I mean don't necessarily quarter-to-quarter though.

On your second question, Yuri. Yes, in the Q4 we did -- do a bit of a reclass between those two expense line items. Just do some cleanup and aligned with how we're thinking about the business. So I can walk you through offline, there was reclassified described between those two lines just relating to the fourth quarter.

[Yuri Lynk, Canaccord Genuity]

Okay. That's good. I'll turn it over guys. Thanks.

[Operator]

Thank you. [Operator Instructions] The next question comes from Zachary Evershed of National Bank Financial. Please go ahead.

[Zachary Evershed, National Bank Financial]

Good morning, everyone. Thanks for taking my questions.

[Robert Brown, President & CEO]

Good morning, Zach

[Zachary Evershed, National Bank Financial]

How rational would you say your competitors are on pricing if the decline in demand accelerates?

[Robert Brown, President & CEO]

It's been, I would say quite rational to this point. Because there's been a lot of inventory in the system, and it really doesn't serve anybody is purpose by behaving more radically on pricing. I think as you get closer to the finish line where people have right-sized their inventory, that's where things may get a little bit more competitive. I feel very good, however, about where we're at in that race in terms of having -- taking the amount of inventory you saw out already and that's a process we are continuing today. So I actually feel like the inventory positioning that we've got now relative to market demand is -- it is getting relatively close to imbalance.

[Zachary Evershed, National Bank Financial]

Good color. Thanks. And so then where do your gross margins go this year if pricing starts to fall volumes downward?

[Robert Brown, President & CEO]

So, I mean there is a couple of things that went on with margin, you saw the write-down which we've discussed and you can kind of add that back, you get into the mid '21. What we've always emphasized is that we've reset the business above '20 where they are today in Q4 even with the write-downs, and what we've seen through January and February. I would say we still have -- we're selling at market with some higher cost levels still in our inventory. So the way to really think about that is probably by mid-year we could start to see a little bit of incremental improvement, we think in that margin because we'll be fully into what I would say is more pricing fully at replacement cost in that market by that time.

[Zachary Evershed, National Bank Financial]

Got you. Thanks. And then just shifting gears, one of your peers stated multiples for M&A had gotten a little bit heated recently. What's your view on that? Do you see any indications that are coming back down to earth? And what's your sense on how bad of a market contraction needs to be before, there are some distressed acquisition options looking for a take out?

[Robert Brown, President & CEO]

Yeah. So we did get a modest tuck-in done in February ourselves, and that was done at very favorable multiples. So there is still deals that you can accomplish. We're active in our conversation. I think that it's really more of a case-by-case basis, to be honest, Zach. A general comment would be people understand that trailing EBITDA numbers, our business included are unlikely to match 2022 and 2023, and so it's really more around that what is the sustainable EBITDA number that's the conversation in these looking at each of these M&A opportunities.

But I for one think that we'll continue to see a good opportunities in front of us that are transactable at prices that we feel are accretive for the business. The distressed sale aspect, that's always one that's very hard to predict. I wouldn't say that thesis, I mean we're adjusting our business, we're going to still make good money this year. Others are taking similar steps and provided they've been as decisive as we have on the inventory, they'll probably be just fine.

[Zachary Evershed, National Bank Financial]

All right. Thank you. And just one last one. What's your sense on how open DOC has been in evaluating industry feedback?

[Robert Brown, President & CEO]

Sorry, I missed that, Zach.

[Zachary Evershed, National Bank Financial]

What’s your sense on how open the industry feedback, the Department of Commerce has been on the trade case?

[Robert Brown, President & CEO]

It's been a bit of a mix. There's certainly been more activity on the political lobbying side, I guess, for lack of a better word, where there's been a number of mainstream members of Congress who have waited -- weighed in, names that you would know. And those things go into the hopper for consideration for DOC but it's very hard to predict to what extent they take them on board and it influences their decisions.

[Zachary Evershed, National Bank Financial]

All right. I'll leave it there.

[Robert Brown, President & CEO]

Thank you.

[Operator]

Thank you. The next question comes from Ian Gillies of Stifel. Please go ahead.

[Ian Gillies, Stifel]

Good morning, everyone.

[Robert Brown, President & CEO]

Hey, Ian.

[Ian Gillies, Stifel]

On the last call, you had provided some detail around how you think working capital release plays out this year tightening up inventory days. Is there any updated commentary in and around how you think that plays out given what's been transpiring in the market or any -- and how the business is performing, so well -- performing this year?

[Robert Brown, President & CEO]

Yeah. So I guess kind of an inventory destocking question, days on hand today is roughly 90. We'd like to be closer to 80. So that's another $40 million to $50 million to come out over the course of the year at current sales pace. I think we get through a good chunk of that by mid-year.

[Ian Gillies, Stifel]

Okay. That's helpful. And Faiz, maybe just if you could give us a hand, the interest cost came in a little harder than we would have thought this quarter. Was there anything unusual in that interest line item or is that just a reflection of higher rates?

[Faiz Karmally, VP & CFO]

It's primarily a reflection of higher rates. We did have some capital lease interest true-ups, but I wouldn't call that material. So a lot of that was just the interest cost, Ian.

[Ian Gillies, Stifel]

Okay. That's helpful. That's all from me guys. A lot of questions were asked earlier on the calls. Thanks very much.

[Robert Brown, President & CEO]

You bet.

[Operator]

Thank you. There are no further questions at this time, I will turn the call back to Rob Brown for closing remarks.

[Robert Brown, President & CEO]

Okay. Thanks for joining us today. We do appreciate the interest in ADENTRA. Faiz and I are available, if you've got follow-up questions, please reach out, we'd be happy to speak with you further. But thanks and appreciate you joining the call today.

[Operator]

Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.