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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 Inc. Second Quarter Results Conference Call. [Operator Instructions] Thank you. Mr. Rob Brown, President and CEO, you may begin your conference.
Thank you, Jessica, and good morning, and welcome everybody. Thanks for joining us today. I'm going to start this morning with a brief overview of our second quarter. Faiz Karmally, our CFO, will follow with a more detailed financial review, and then I'll return to make some comments on our outlook. I'm pleased to report that we generated solid top and bottom line growth again this quarter. As it relates to sales, we increased volumes as we responded to healthy levels of market demand. We also achieved higher prices on some of our products as we passed along product price increases to customers. Our acquisition strategy continues to contribute positively. And second quarter results included a full quarter of activity from Downes & Reader Hardwood Company, which we acquired a year ago in July and which increased our presence in the U.S. Northeast. We also had about 3 weeks of results from assets we recently acquired from the Atlanta Hardwood company. That transaction brought us 3 new operations in Georgia and Alabama. Sales from our U.S. operations, which represented about 85% of our sales mix, climbed 12.4% year-over-year. This performance was comprised of organic growth of 8.6% and acquisitions-based growth of 3.8%. And sales from our Canadian operations were up 4.1% year-over-year due in part to an extra selling day in Canada this quarter as compared to a year ago. On a sales-per-day basis, sales in Canada were up by 2.4% year-over-year in terms of organic growth. On the bottom line, adjusted profit increased 8.8%, and adjusted profit per share increased to $0.49, up from $0.45 a year ago. This was significant given that, as anticipated, our gross margin percentage experienced some compression related to the U.S. trade action against imported Chinese hardwood plywood. We estimate that trade case negatively affected our Q2 gross profit by $1.2 million and our adjusted profit by $0.9 million. We were also contending with a stronger Canadian dollar during this quarter, which reduced adjusted profit by a further $0.4 million. So achieving an 8.8% increase in adjusted profit was a positive development in this environment. The recent reduction in the U.S. corporate tax rate played a role in this, as did our continued careful management of the business. Our results, combined with our strong financial position and our positive outlook, led to the board's decision to raise our quarterly dividend by 10% to $0.08 per share. This is our seventh dividend increase in the past 7 years. That brings our annual dividend rate to $0.32 per share. The business is performing well. We're very pleased to be sharing our success with the shareholders. At this point, I'll ask Faiz to review our second quarter financial 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 2018, and then I'll provide some comments on our financial position. Starting with second quarter consolidated revenue, our sales increased 7.4% to $298.2 million. That's a gain of $20.7 million compared to last year, and it breaks down as follows: Organic growth contributed $22.2 million to sales or 8%; and acquisitions accounted for $8.9 million of the year-over-year increase or 3.2%. These gains were partially offset by the $10.5 million negative foreign exchange impact of the stronger Canadian dollar. Second quarter gross profit grew by 2.8% to $53 million. That's an improvement of $1.5 million, and it reflects the higher sales, partially offset by a lower gross profit margin, primarily related to the trade case. As a percentage of sales, our gross profit margin was 17.8% as compared to 18.6% last year. Without the impact of the trade case, we estimate that our gross margin would have been 40 basis points higher in the second quarter of this year. Operating expenses were up $2.8 million year-over-year, primarily reflecting the addition of expenses from acquired businesses and costs incurred to support organic growth. As a percentage of sales, operating expenses remained steady at 13%.Turning to adjusted EBITDA, this was $16.8 million in the second quarter, down from $17.2 million last year. As Rob noted, the trade case had an estimated $1.2 million negative impact on adjusted EBITDA while the stronger Canadian dollar reduced adjusted EBITDA by $0.6 million. Our income tax expense decreased to $3.4 million from $5.1 million in the same period last year. This was primarily driven by the lower Federal corporate tax rate in the U.S., which is now 21% as compared to 35% previously. And adjusted profit increased by 8.8% to $10.6 million or adjusted diluted profit per share of $0.49. That was up from $9.8 million or $0.45 per share in Q2 last year. The improved result reflects the lower U.S. tax rate, which fully offset the trade case impact in the quarter.Turning now to results for the first half. 6 months consolidated sales climbed 6% to $568.9 million, a year-over-year improvement of $32.1 million. Of this sales growth, organic growth accounted for $35.8 million or an increase of 6.7%. Acquisitions accounted for $17.4 million, representing a 3.2% increase in sales. These gains were partially offset by a negative foreign exchange impact of $21.1 million. Sales in the U.S. were up by $38.6 million or 11% year-over-year. And sales in Canada grew by $2.4 million or 3.4% compared to the first half of 2017. First half gross profit increased by 1.9% to $101.7 million as a result of the higher sales, partially offset by a lower gross profit margin of 17.9% as compared to 18.6% last year.6 months operating expenses increased by $4.2 million, reflecting the addition of acquired businesses as well as added costs to support organic growth. These increases were partially offset by a positive impact of a stronger Canadian dollar on our U.S. operating costs. Our first half income tax expense decreased to $5.9 million from $8.9 million in the same period last year, again, primarily driven by the lower U.S. corporate tax rate. This, in turn, helped us increase first half adjusted profit by 7.1% to $19 million, and adjusted diluted profit per share increased to $0.88 from $0.82 in the same period last year.Turning now to our financial position. In the second quarter, we increased purchasing of certain product lines to secure supply and to cover seasonal demand needs. Due to some price appreciation in the market, the value of certain inventory is also higher than previously. Even with these investments, our net debt-to-EBITDA ratio was a conservative 2.3x, and our debt-to-capital ratio was just 32.4%. We also had $60.6 million of unused debt capacity available.Going forward, we're well positioned to pursue our strategies, fund growth and support our dividend. Now I'll turn the call back to Rob.
Okay. Thanks, Faiz. Our outlook for the second half of 2018 is positive. On the market front, we're anticipating a continuation of mid- to high single-digit organic market growth in our U.S. end markets. And in Canada, we're expecting low to mid-single-digit organic growth. Our intention is not only to capture the available market growth but to continue building on it through the successful implementation and execution of our own strategies. Based on the healthy demand levels and the continued alignment of product prices with costs, we expect gross profit dollars, EBITDA and profit will be better in the third and fourth quarters of this year than in the same periods last year. Overall, we are encouraged by our prospects going forward. We believe we're in an excellent competitive -- or positioned competitively. We're North America's #1 distribution company in our space. We've got 3 of the industry's best-known, most-respected distribution brands. We've got significant depth in our management team, and we're attracting the industry's best people across our operations, and we've really become the leading choice of suppliers looking for a sophisticated North American-wide distribution partner. As you know, we also have an established pipeline of acquisition opportunities in what is a fragmented industry. And we intend to continue to complement our organic sales growth with attractive acquisitions that further enhance our market position and enable us to respond to the significant growth opportunities in the U.S. We also have a strong balance sheet, as Faiz mentioned, which positions us to pursue these business strategies. So as we move forward, we remain committed to the disciplined and strategic business approach. It's translated into a long track record of improving performance at HDI and which, in turn, has enabled us to reward investors with our seventh dividend increase today in the past 7 years. With that, I want to thank you for your attention, and I'll turn the call back to the operator, Jessica, to provide further instructions for the Q&A period. Jessica?
[Operator Instructions] Your first question comes from Hamir Patel of CIBC Capital Markets.
Rob, have you seen much movement in hardwood plywood prices in Q3 so far?
Q3, not so much. But we've definitely seen on a year-to-date basis and, certainly, since the trade case ruling came down, upward movement in that product category.
Okay. And is there any way to maybe quantify what that's -- how much that's moved up maybe year-to-date or since the trade case?
Difficult to give you a number that you can go, "that's the number." It varies very much by SKU and [ specie ] and, basically, type of end product, but it's a double-digit gain.
Okay. Fair enough. And in the outlook, you'd pointed out to gross margins in the back half coming in probably at the lower end of the 18% to 19% target range. Are you able to yet say where you see things playing out maybe in 2019 on the gross margin front?
A little early just because, as you know, we're trying to rebuild a consistent flow of alternate product choices for customers, both domestic and from other countries since the trade case. We really need that to settle down into a normal pattern to see where the overall mix would be. The comment I'd make on gross margin is, yes, we think it's going to be in the lower end of that 18% to 19% in the upcoming quarter. But I do think that, that trend's up over time, I just can't give you a precise expectation where it ends up until we've got the flows going from those various sources.
Okay. Fair enough. And the other thing I wanted to ask you about was with all this talk about tariffs heating up between the U.S. and China, do you see any risks of price deflation for the hardwood lumber product category? I'm just thinking if there's maybe less take away to China hardwood lumber, and then also potentially maybe more domestic production of hardwood lumber in the U.S., if there's less logs going to China as well. So just what potential impacts you see there.
Yes. No, actually, I think as you've described it is reasonable. To the extent that there is takeaway of both hardwood lumber and raw logs from the U.S., principally the Appalachian region, that gets bought by Chinese buyers and heads overseas. If through the various actions we've got going in the U.S., there's disruption to that supply, then you are going to see more of that product stay in North America, and I think that, that would probably provide some downward pressure on that particular product category. What I would say is that's one of many product categories we're in. And we are seeing corresponding price appreciation in other places, so it's not something that we're unduly concerned about.
Your next question comes from Nick Corcoran of Acumen Capital.
I have 2 quick questions. So the first question is on the alternate supply lines. Can you provide any commentary on where you are having -- sending those off?
Yes. So without kind of getting too much into competitive information, we, like others, are trying to provide solutions to our customers. And our customers want both import opportunities as well as domestic opportunities, so we provide that. The domestic -- or pardon me, the import opportunities from China, as you know, is largely off the table. And so that's caused us and others to look into other jurisdictions. Where we're at in that process is that we have secured a good flow of supply. We've got product arriving in North America. It takes some time for that to flow through the system, get in the hands of customers to try it and make sure they like that product from new alternate sources overseas, and make their decisions in terms of buying. So that's why we really said we thought the trade case impact would linger through the first half of this year, and it would really be in the second half of this year that we kind of start to return to some normal trading patterns. But I guess I would emphasize to you that we're not -- we're well out of the starting blocks on this, and we've actually got product arriving in North America that we're putting in front of customers.
That's great. And then just on the organic growth in the U.S., you saw strong organic growth. Can you just comment on the mix between residential and commercial? And if there's any takeaways over whether one of those sectors is growing at a faster rate than the other?
Actually, both our residential cabinet customers and our commercial customers, which are more project-based, are busy. So I wouldn't draw a particular distinction in terms of growth rate between those 2 end markets. One thing that's nice about how we've grown the business is it is a bit more balanced as between residential and commercial. And now, we're into geographies around North America, which also provides some geographic diversification. And we're in more product categories than we were a number of years ago, which gives us a little bit of diversity. So we're seeing, overall, good growth patterns across the piece.
Your next question comes from Russell Stanley of Echelon Wealth.
I guess, first question, just following up on the organic growth question. You saw -- you mentioned seeing both price improvement and improved volumes. Was it equal parts those? Or was it more of a volume lift or a pricing lift that you saw on the quarter?
I thought someone would ask the question, Russ. I always give a slightly apologetic answer which is, we don't have perfect transparent insight into that, just given the SKU mix and the various ways that we sell the products by piece, by board, et cetera. So I'm going to have to give you a little bit more of an anecdotal answer, which is to say, certainly, price appreciation plays a role. I would not pin the organic growth entirely on volume-based growth. So where that splits out precisely, I don't have a number for you. But I think it's fair to start with a 50-50 at least in mind. So I don't -- I wouldn't want to de-emphasize or emphasize one over the other.
Great. That's helpful. And just looking into -- given what you've seen on products actually getting to North America, should we assume that the Q3 trade case impact is roughly similar to Q2 levels? Or should we see a moderation this quarter, an improvement continuing in Q4?
I think just a continued trend towards some recovery on margins is what we'll be looking for. But as I mentioned earlier, I think in response to Nick's question, it's just going to take some -- it's going to take some time for that to occur.
Your next question comes from Chris Keefe of Canaccord Genuity.
Just to start off. We saw a bit of a working capital investment that was a little bit higher than in previous quarters in Q2. Was that just continued advanced buying? And do we expect that to unwind by the end of the year?
You did see that. And there's a few things going on that are maybe worth mentioning. One is, some of the product is more expensive. So just in terms of same volume, higher-priced product, is obviously going to show up with a bigger number on the balance sheet. But having said that, I would say, yes, we also are a little bit heavier. Some of that is just seasonal, obviously, for Q2, and that's in line with our normal patterns. And then the other piece of it is, it's been a bit of a choppy market, as you can probably appreciate on the hardwood plywood side with some of the trade disruptions, and that has caused us to carry more inventory, more safety stock as we move through that, because our first priority was to make sure we never ran a customer out of wood and that we always had solutions for them through the disruption in the market. So we have chosen to be a little bit heavier in some products in some places. I do expect that we unwind that over the balance of the year.
Okay. And then just as usual, just checking in on the M&A outlook and if anything has changed.
I feel very good about the M&A outlook. We've got a pipeline that is very tangible and that we're working actively. We've got resources specifically dedicated to doing that. We're having good conversations. And the expectation we've kind of talked about is we want to continue to augment our organic growth with acquisitions growth at a consistent pace year-over-year. So deals are always lumpy. We've got one under our belt for this year, but I expect to continue to be active in that space and feel optimistic about it.
[Operator Instructions] There are no further questions at this time. Please proceed.
Okay. Thanks, everybody, for joining. I appreciate the questions and, as always, your interest in HDI. If you've got follow-up questions, please do reach out to Faiz or I directly, and we'll be happy to chat with you more about it. Thank you very much.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.