Hardwoods Distribution Inc. (OTC:HDIUF) Q2 2020 Earnings Conference Call August 10, 2020 11:00 AM ET
Rob Brown – Chief Executive Officer
Faiz Karmally – Chief Financial Officer
Conference Call Participants
Hamir Patel – CIBC Capital Markets
Yuri Lynk – Canaccord
Zachary Evershed – National Bank
Good morning ladies and gentlemen and welcome to the HDI Q2 2020 Results Conference Call. At this time, all lines have been placed on listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions]. Also note that the call is recorded Monday, August 10, 2020.
At this time, I would like to turn the call over to Mr. Rob Brown. Please go ahead.
Thank you, Sylvie. Good morning and welcome everyone. Thanks for joining us. Let me start this morning with a brief overview of the highlights from our second quarter. Faiz Karmally, our CFO will follow with our financial review. Then, I’ll return to discuss our outlook going forward.
We achieved strong results again this quarter, even while navigating the challenges of the COVID-19 pandemic. As most of you are aware, our business experienced an abrupt slow down in organic sales in April, as customers and markets adjusted to the new realities. Organic sales for April were off by about 20%, as compared to the same month in 2019. However activity began to recover in May and June and together with contribution from acquisitions and a positive foreign currency impact, we achieved a second quarter sales pace that was close to what we achieved in 2019.
At the same time, we strengthened our bottom-line performance, and in fact, set some new records. Our gross margin percentage of 19.5% and adjusted EBITDA of $24.4 million were the best quarterly results in our history, and we increased quarterly profit per share by over 26% to $0.48, a very strong result. Our ability to not just weather the impact of the pandemic, but to improve our performance in the midst of it, reflect a number of factors: First, we took early actions to adjust our business to the changing conditions. We started by ensuring a safe environment for employees and customers, which in turn enabled us to keep our operations up and running, and we moved quickly to increase our organizational focus on tightly managing expenses, taking significant costs out of the business and to reduce working capital, to reflect the current sales pace. Importantly, we did this in a way that did not impact our productive capacity.
Secondly, we continue to benefit from our business strategies. Our success in reestablishing our direct import supply lines contributed to our record gross margin percentage and our acquisition strategy further bolstered our performance. In particular, our acquisition of Pacific Mutual Door Company, which we completed last October has enhanced our product mix with a higher margin offering.
Taken together our actions boosted our profitability and combined with the reductions in working capital we achieved cash flow from operating activities of over 58 million for the quarter. That’s an excellent result and one that enabled us to continue pursuing our capital allocation priorities. I’m pleased to report that we further strengthened our financial position in Q2 by reducing our bank debt by nearly $41 million. We also returned value to shareholders in the form of dividends and share buybacks and we continue to invest in business strategies that help to grow the company and further differentiate us from competitors. Overall, it was a strong quarter and I want to thank all the members of the HDI team for their achievements in the midst of challenging operating conditions.
Now, I’ll turn the call over to Faiz and he can discuss our Q2 results with you in more detail. Faiz?
Thank you, Rob, and good morning, everyone. I’m going to provide a general overview of our results for the second quarter and the first half of 2020. And now I’ll provide some comments on our financial position and capital allocation plans. Starting with second quarter consolidated revenue, we generated sales of 296 million, and that was 2.8% or 8.5 million lower than a year ago, and it breaks down as follows: organic sales was 38.1 million or 12.5% lower reflecting impacts from the COVID-19 related slowdown in economic activity.
This was partially offset by contributions from acquired businesses which added 21.3 million or 7% to our sales. We also realized the translation gain of 8.4 million related to the positive foreign exchange impact of a stronger US dollar. In the US sales were US 9.9 million or 4.9% lower year-over-year, expected a decrease in organic sales, partially offset by the benefits by businesses. And in Canada, sales were lower by 4.8 million 13.2%, reflecting the COVID-19 related slowdown in economic activity.
Turning to gross profit, it excludes 57.8 million in the second quarter, an increase of 5.1% or 2.8 million in the same period last year. The year-over-year improvement reflects the increase in gross profit margin to a record 19.5% from 18.1% last year. Operating expenses for the second quarter were modestly higher at 42 million, an increase of just 0.8 million. Although acquired businesses added 4 million of new operating expenses, and we had 1.2 million of expenses related to the impact of the stronger US dollar on translation of our US operating expenses. These increases were largely offset by the actions we took in response to rapidly changing market conditions, and our heightened organizational focus on tightening managing expenses. These actions successfully lowered accounting expenses by 4.4 million year-over-year.
As Rob noted, we generated record quarterly adjusted EBITDA of 24.4 million, which was 16.3% year-over-year. This strong result was driven by our higher gross profit and our success in lowering organic operating expenses. And profit grew significantly to 10.2 million from 8.2 million last year, while diluted profit per share improved to $0.48 and $0.38 in the same period last year. These represent increases of 25.3% and 26.3% respectively.
Turning now to the results for the six months ended June 30th. Our first half sales increased by 5% to 621.1 million, the year-over-year improvements of 29.5 million. Acquisitions contributed 40.6 million or 6.9% increase in sales, while foreign exchange translation had a positive 11.8 million impact. These gains were partially offset by a 23 million or 3.9% decrease in organic sales. In the U.S. sales were up by US 14.1 million a 3.6% year-over-year reflecting the benefit of acquired businesses partially offset by the COVID-19 related decrease in organic sales.
In Canada sales were lower by $2 million or 2.9%. Our first half gross profit increased by 13.5% to $120.4 million and that was the result of higher consolidated sales from the improvement in gross profit margin to 19.4% from 17.9% last year.
Six months operating expenses increased by $7.3 million reflecting the addition of acquired businesses as well as the translation impact of a stronger US dollar on US operating expenses. These increases were significantly offset by the cost management and cost reduction measures we implemented during the period. Adjusted EBITDA for the first half climbed to 22.7% to $47.2 million an $8.7 million increase. This reflects the higher gross profit partially offset by the increase in operating expenses.
And we significantly increased year-to-date profit by 38.7% to $19.6 million and diluted profit per share increased by 41.5% to $0.92 from $0.65 in the first half of 2019.
Looking now at our financial provision and capital allocation priorities. The priority we have placed on maintaining a strong balance sheet compares in our results. As of the end of the second quarter, our net debt to adjusted EBITDA after rents ratio had decreased to 1.3 times from 2.2 times at the end of Q1. And our net debt to capital ratio was 21%.
We also have over $111 million of liquidity available in the form of cash on hand and unused debt capacity at the end of the quarter. We remain confident in our ability to manage through short term disruptions caused by the COVID-19 situation. Going forward, our capital allocation priorities 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 remaining opportunistic as it relates to share repurchases and ensuring continued responsible management of the balance sheet.
Now, I’ll turn the call back over to Rob.
Thanks Faiz. As we move forward, the ultimate impact of the COVID-19 pandemic remains difficult to quantify. It’s going to depend on the duration of the contagion, the impact of government policies and of course the subsequent pace of economic recovery. As I noted earlier, we saw demand levels start to recover in May and June and this trend continued into July. Organic sales for July 2020 were the same as in July of 2019 for us. While the summer months tend to be our strongest we’re pleased to see solid activity levels in the end markets we participate in. And we’re seeing encouraging signals from the residential construction market, housing permits and starts are up, interest rates are at historic lows. And demographic trends remain favorable all of which to set the stage for demand growth in the near to mid-term.
In the commercial market, we’re seeing more of a mixed situation. But keep in mind that commercial encompasses everything from our reconstruction to furniture manufacturers, to institutional builders of hospitals and schools and commercial builders of retail and hotel projects. It’s a diverse market, and some of these end markets will perform better than others.
Overall, we remain confident that we’re well-prepared to respond to market uncertainties flowing from the COVID-19 pandemic. Our business is larger, it’s stronger, and it’s more diversified than it’s ever been. We have no significant geographic supplier or customer concentration. We have a business model that’s proved itself resilient through over 60 years of changing economic conditions, and as we showed you the first half of this year, one that’s well-positioned to absorb impacts.
And as I’ve mentioned previously, our leadership team has considerable practical experience gained in the 2008 global financial crisis. Our balance sheet is also an excellent shape with significant cash generating ability, no term debt and over $111 million of liquidity. As we move forward, we’re well-positioned to act on our opportunities to win new market share, advance our product and technology strategies and grow through acquisition. Overall, we remain well-positioned to create value for shareholders.
With that, I want to thank you for your attention. I’ll now turn the call back to Sylvie to provide instructions for the question-and-answer period. Sylvie?
Thank you, Mr. Brown. [Operator Instructions]. And your first question will be from Hamir Patel at CIBC Capital Markets.
Hi. Good morning. Rob, could you speak to what you’re seeing in some of those various commercial end markets you mentioned?
Yeah. I can give a little bit of color on that. So we think commercial, there’s lots of ways you can slice it up Hamir. But, if you think of say education, healthcare, hospitality, office building and store fixturing, I think they’re the ones that are most obviously going to be the challenge going forward would be the hospitality piece. It include the rebuilds and such. And that’s just an obvious from the slowdown that we’re seeing in travel business, travel and leisure travel. The other one is, probably shore fixturing, again a little bit softer in the current environment. But we do see spending in healthcare and healthcare doesn’t just mean hospitals. It means any kind of associated care facilities that is looking good going forward, a little bit more mixed as it relates to education and office buildings.
So, that’s maybe a little bit of the way that we’re thinking of it and keep in mind commercials, it flashes a little bit, but maybe 40% of our business on an overall basis, longer-term basis. But today we would say we’re seeing that, diminished somewhat and replaced instead with residential and you’re well aware of all the strong signals we’ve going through residential we’re participating with.
Thanks, Rob. That’s helpful. And some of your the more commodity distributors have some really good price comps in Q3 for softwood building products. Could you speak to for some of the larger categories at Hardwoods lumber, Hardwoods plywood. What are the year-over-year pricing dynamics that you see in the third quarter?
Yeah, I’m glad you brought that up. So I like you have been following some of the building products companies and there’s been some good results out there but largely influenced by product price inflation. That’s really not our case. You saw our top line performance was less impacted by movements in the categories we’re participating in. So if you look at something like hardwood lumber, and that’s an index that’s visible to you, you can see that still not picked up really at all, very much in contrast with what you see on the softwood lumber side of things.
On the other hand, we have increased our participation in the door lower category and particularly with the acquisition of PMD. And we have seen product price strengthening there, but if you look at our, significant volume, right improvement. It’s really driven by being defensive on sales and really doing a good job of offsetting any COVID related impacts, but then strengthening on margin and taking some cost out of the business. It’s not as dependence upon commodity type pricing.
Great, thanks Rob. That’s all I have.
Thank you. Your next question will be from Yuri Lynk at Canaccord. Please go ahead.
Good morning, guys. Nice quarter. Wanted to dig in a little bit on the gross margin. Obviously, extremely strong and I think above the upper end of kind of the range that you’ve targeted in the past. Just want to get an idea of what drove that and maybe you can talk about, I understand PMD is higher margin, but at the same time, I think it’s only 7% or 8% of annualized sales. Is the import program, higher margin than it used to be? And is there any mix that hit in the quarter that might have driven the margin higher?
Yeah, thanks, Yuri. And we have said in the past 18% to 19%, gross profit range has been, where we’re at and we’re operating above those in the current quarter and year to date. The two things that we pointed out, certainly were the return of our ability to import on a direct basis. There was things that we were able to do you recall in the past just because of pending trade outcomes. And those have largely resolved themselves so that’s been a positive contributor and then adding in the PMD acquisition as well. So, if you take out PMD, you would get closer to the high end of our 18% to 19% historical range. PMD is going to continue. So that’s a nice firm contributor.
It’s going to be a little bit late, we’ll see where we’re going to end up in that range over a longer, longer term basis, but we certainly do things that we’re operating near the higher end for a little piece of time here.
Rob any of the costs that you took out of the business aggressively in the quarter? Did any of that show up on the gross profit line?
You would have some trucking that would go in there. So as you flex the business or kind of coordinated for sales pace. You’re going to add or drop trucking capacity. But that’s very normal for the business. We’re doing that all the time. But it does go into profit.
Okay. And is the import program still about a quarter of your sales?
I mean, expenses here. Yes, roughly about quarter or so.
And second question, if I can count all that as one, maybe just an update on the acquisition environment as we go through very volatile macro, any change in the opportunities that are out there in terms of what you’re seeing?
Yes. So, when we did this call three months ago, I think there was a question about whether we’re off the acquisitions training because of the uncertainty at the time, we said no, we’re going to get to NAV cost, because of market conditions, practically speaking, but the actual looking and pursuing and nurturing our pipeline is going to continue. So, we did that in the quarter. We still have conversations are ongoing and we consider it an active part of our strategy. I mean, it’s just an obvious little bit of a distraction because if you think of targets, and they were managing through a pandemic, for one, many of them were pursuing triple PPP loans from the US Government, for two and the completion of due diligence with the inability to travel needs a little bit more challenging, I would say now as we look into the current quarter, as we have many of those targets are feeling good and stable. There’s through that kind of PPP loan distraction and we’re seeing some sort of limited travel that we’re able to do and accomplish things remotely. So, we still very still feel very good about the acquisitions pipeline, really no change. It’s well staffed, we got lots of cash capacity to execute on that. And the deals that we’ve done in the recent past have turned out frankly well for us, specific which will be the most recent so we’re still very much on the path there, Yuri.
Thank you. Next question will be from Nick Cortman at Acumen Capital. Please go ahead.
Good morning. Just couple of follow questions from me. The first is on the gross margin. I think in the past you mentioned that reducing your inventory could have a potential drag on gross margin. Did you see any of that in this quarter?
So, we did have a sense of urgency particularly early in the quarter to take working capital down, because I think all of us weren’t quite sure what the shape of the world was going to be. And when you do do that, you can have some drag on inventory and trying to do things more quickly than would be normal practice. I don’t think that I would call out any particular drag this quarter on that at all, it was done in quite an orderly fashion.
And then just on that topic of working capital and bringing down this cause of urgency. As you return to organic sales growth year-over-year, how should we think capital going forward?
So, yes a couple of points there. Working Capital did come down significantly in Q2. And some of that was driven by again, if I’m growing the business organically, the working capital needs as you mentioned, historically, if you think about in terms of for every dollar of sales, there’s typically $0.20 to $0.25 of working capital that goes in behind to support that. So, what sales do grow organically, that will be net working capital and that’s not requires, I would say going forward based on the assumption.
Great. And then the last question for you maybe just on the M&A pipeline. How should we think about the pipeline going forward and do you see any potential targets like PMD on your radar screen or is it more of a mixed bag of targets?
There’s definitely a range of targets in there. And honestly, it’s hard to predict which ones get to the finish line or not, that’s why we have a fairly wide swath of effort on the acquisitions. What I would say is, when you think of the ownership group of targets, they’re typically selling because, they’ve built the businesses. But they don’t necessarily have succession in place internally with family or otherwise. And a lot of those owners are, they’re getting older and looking to move into retirement years. A number of them would have lived as we did through the global financial crisis of 2008 and they rebuilt their business, and now they’ve gone through 12 years later, another fairly rude event in terms of the pandemic, which I think is going to be more of a motivator to say, it’s time to move on. And I actually think it would be quite a good environment for continuing with the pipeline.
Great. That’s it for me. Thanks a lot.
Thank you. [Operator Instructions]. And your next question will be from Zachary Evershed of National Bank Financial.
Thank you. Good morning everyone. Congrats on the quarter. Could you give us a bit of dive into what products were stronger and which were weaker in the quarter on the residential side? And how that trended each month and into August?
Well, that’s almost a four dimensional question. So I mean, I wouldn’t distinguish product strength between residential and other. I mean, we tend to sell the mix and I wouldn’t call out, it’s changing mix. In terms of growth, I’m thinking more in terms of percentages. I mean, it’s inline with what we’ve seen recently, which is some of the decorative surfaces categories tending to be a little bit stronger growth than the traditional wood products categories, and that’s just really reflective of consumer demand and the types of products that people want to see in their kitchens or any finishing kind of applications of the homes.
So doors, obviously I mentioned earlier, prices were stronger, but also, that’s been a very nice piece for us in terms of strength into the residential side of the business, and then those kind of laminate type surfacing products as well, probably worth calling out.
Thank you. And how much impact the government grants have in the quarter?
Government grands to HDI?
No, we’ve not taken any government money. We’ve seen customers participating certainly in the US with the PPP loans and but not directly in our business.
And with the $4.4 million increase year over year in organic cost savings, how much of that is on emergency focusing put us away as you brand Ecka and how much sticks around going forward.
So, I don’t, not going to provide a specific kind of cost rate down on that but I will say we’re being very disciplined about adding costs back in, so because we were like everybody being a little bit cautious or really on top of things early on we took kind of a harder view of reducing costs and before we add anything back we are being very disciplined to make sure that it’s a requirement. So you know some things that are very natural that flow precisely with or maybe side step change with sales like Yuri’s earlier question, trucking if you’re going to move more product you’re going to add back in a truck as a example so that will come back. But it’s self supported by the volume generally. Other cost
areas such as we did reduce our headcount by about 10%. You can add back in sales without having to take that cost back on in a short term basis, and that’s what we’re trying to achieve. Again, just as we see, what monthly sales so in acquisitions or some certainly around demand going forward, even though we’re quite positive and bullish on the demand for our specific sectors that we participate in.
That’s real helpful, thanks. And last one for me your buyback strategy with the stock knocking on $20?
Yes, we’ve always said that we’re going to be optimistic on that. And we discuss it regularly with the Board. So, we’ll give you a little bit of that in the quarter. But then, like many we were very cautious with our cash and we wanted to see how things are going to develop. And we’ll see the same approach going forward. I think as Faiz discussed in the capital allocation priorities, we’re going to run a strong balance sheet. We’re going to execute on our acquisition strategy that’s important to us. And returning value to shareholders through dividends and share buybacks.
Thank you. And at this time Mr. Brown, we have no other questions registered please proceed.
Okay. Thanks, everybody, for joining us today. Appreciate the interest shown in your questions. And if you’ve got follow-up questions, please do reach out to Faiz and myself, we would happy to talk with you. So, have a good day.
Thank you, sir. Ladies and gentlemen, this does indeed conclude the conference call for today. Once again, thank you for attending and at this time we do ask you to please disconnect your lines.