H
Hardwoods Distribution Inc
TSX:HDI
Hardwoods Distribution Inc
TSX:HDI
Price:
35.1 CAD
0.11%
Market Closed
Updated:
May 4, 2024
Section:
Earnings Call Analysis
Summary
Q2-2023
Q2-2023
Adentra Anticipates Stabilized Q3 Similar to Q2
Adentra recorded $585.9 million in Q2 sales, a 16.3% decline from the previous year, primarily due to lower volumes and partly price deflation. Despite the decline, the company managed a Gross Profit margin of over 20% for the 9th consecutive quarter and achieved $46.2 million in adjusted EBITDA. The company also reduced its debt by $243 million while returning $36 million to shareholders. For Q3, Adentra forecasts adjusted results to mirror Q2 with the market normalizing and predicts the leverage ratio to remain around 3x through the year's remainder.
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Good morning, ladies and gentlemen, and welcome to Adentra's Second Quarter 2023 Results Conference Call. [Operator Instructions]. This call is being recorded on Friday, August 11, 2023.
I would now like to turn the conference over to Ian Tharp, Investor Relations of Adentra. Please go ahead.
Thanks, Joanna, and good morning to those joining today as we discuss Adentra's financial results for the second quarter of 2023. With me on the call today are Rob Brown, Adentra's President and CEO; and Faiz Karmally, Vice President and CFO. Adentra's Q2 2023 earnings release, financial statements and MD&A are available on the Investors section of our website at www.adentragroup.com. These statements have also been filed on Adentra's profile on SEDARPLUS at www.sedarplus.ca.
I want to remind listeners that management comments during this call may include 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 for a discussion of the risks and uncertainties associated with these forward-looking statements. All 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?
Thanks, Ian. Good morning, everyone. We're pleased to share details of Adentra's financial and operating results for the second quarter of 2023. I'll start with our key financial and business highlights for the quarter. Faiz, our CFO, will then provide details of our Q2 financial results. I'll finish off our prepared remarks with what we see looking forward now that we've closed out the first half of 2023.
We generated $585.9 million in sales, $46.2 million in adjusted EBITDA and adjusted earnings per share of $0.56 in the second quarter. As described in our previous outlook, rising interest rates, we're expected to reduce demand for architectural building products in the near-term. We anticipate reduced financial performance in 2023 and as compared to the record-setting levels achieved in 2022.
Second quarter results were in line with our expectations. We delivered sequential improvement in sales volumes, gross margin and EBITDA margin as compared to Q1 of 2023. Even in this period of reduced demand and product price deflation as compared to 2022, we're demonstrating the resilience of our business model. Second quarter sales were down 16.3% as compared to the same period in the prior year. Approximately 2/3 of the decrease reflected lower volumes, and 1/3 of the decrease related to product price inflation or deflation.
On a sequential basis, our sales volumes were up mid-single digits in the second quarter as compared to Q1 of 2023 and this was offset by product price deflation of a similar amount. Our gross profit percentage of 20.4% improved upon the 20.2% we posted in Q1 and this marks our ninth consecutive quarter with a gross profit margin above 20%. Operating expenses continue to be tightly managed and were up [indiscernible] compared to the same period in the prior year. This is a good result considering the inflationary environment that has persisted in the economy since 2022. Our operating results drove strong cash flows from operations and demonstrates our ability to consistently generate significant cash flows during periods of reduced economic activity.
Similar to prior quarters, cash flow generation came from both the predictable conversion of adjusted EBITDA to operating cash flow before changes in working capital and from the release of working capital. The capital generated has been deployed in accordance with our plan. In Q2 last year, having recently acquired Mid-Am using our credit facilities, we stated our objective to focus on debt reduction since the second quarter of last year we've reduced debt by $243 million. Over the same period, we've returned over $36 million of cash to shareholders in the form of share repurchases and dividends. As we advance through the remainder of 2023, we continue to monitor the impacts the changing economic conditions such as inflation and higher interest rates can have on our business. I'll provide more details on our business outlook before we wrap up today's call, and I'll now turn the call over to Faiz to review the Q2 2023 financial results in more detail. Faiz?
Thanks, Rob, and good morning, everyone. I'm going to provide the details of our financial results for the second quarter of 2023 and outline our financial position at quarter end. Again, I'll remind those listening that any dollar figures Rob and I are using today are in U.S. dollars, unless we've stated otherwise.
Starting with consolidated revenue, we generated sales of $585.9 million in Q2 of 2023, which was a decrease of 16.3% or $114.3 million compared to Q2 of 2022, which was a period of unusually high demand and increasing prices. Lower volumes were the primary driver of the year-over-year decline in sales with some impact also felt from price deflation. Also contributing to the Q2 decline in sales was a $2.3 million unfavorable FX impact due to the translation of our Canadian sales into U.S. dollars for reporting purposes.
Focusing regionally, sales in our U.S. operations were $541 million, which was 16.2% lower than the corresponding quarter in 2022. The decrease was largely volume driven with some impacts from price deflation. Canadian sales in Q2 were CAD 60.4 million, which was 13% lower than the same period in 2022. Similar to the U.S. market, the decrease in Canadian sales reflects lower volumes and price deflation.
Turning to gross profit. We earned $119.4 million in the second quarter, a 22.3% decrease as compared to Q2 in 2022. This change reflects lower organic sales and a gross profit percentage of 20.4% as compared to 22% in the same period last year. Our gross profit percentage in the prior year was temporarily elevated due to favorable market dynamics, including strong demand and tight supply. Our operating expenses for the second quarter of 2023 were $94.4 million or $1.5 million higher than Q2 of 2022. The increase primarily relates to higher premise costs and LTIP expenses as compared to the second quarter of 2022.
Moving now to adjusted EBITDA. Q2 2023 was $46.2 million, a decline of 41.3% that was primarily driven by lower year-over-year gross profit. As a percentage of sales, our adjusted EBITDA margin was 7.9% for Q2 of 2023 as compared to 11.2% in Q2 of 2022. Finally, Q2 profit was $9.4 million, a decline of $32.5 million from the same period in 2022. This change was driven by the reduced EBITDA mentioned earlier, increased depreciation and amortization of $1.2 million and $6.3 million in additional finance expenses, which were offset by a $9.7 million decrease in income tax expense. On a per share basis, basic profit was $0.42 as compared to $1.77 in Q2 of 2022. Adjusted basic earnings per share was $0.56 as compared to $1.81 in the same period last year.
Taking a look at our operating cash flow from the quarter. This increased $26.1 million to $52.8 million. Of this amount, $35.9 million was generated from the reduction in inventory levels in the second quarter.
Turning now to our balance sheet. Our strong cash flow generation enabled us to reduce debt by a total of $51.7 million. We exited Q2 in a solid financial position with a leverage ratio of 3x and an unused borrowing capacity of over $375 million. Our strong balance sheet shows the resilience of our business model and provides us with ample flexibility to manage any short-term headwinds, fund future growth and continue to advance our business strategies. Our capital allocation strategy remains intact and prioritizes the continued responsible management of our balance sheet, funding organic and acquisitions-based growth and providing incremental total returns to shareholders.
With that, I'll pass the call over to Rob. Rob?
Thanks, Faiz. I'll conclude my comments this morning with our views on end markets and details on our strategy to continue building the long-term value of Adentra. In the near-term, we continue to expect with inflationary pressures as well as increased interest rates will have a dampening effect on economic activity. This in turn is expected to result in reduced product demand and could lead to softer product volumes and pricing as compared to the same period in the prior year.
As a result, and as we experienced in the first half of 2023, we expect our financial performance through the remainder of 2023 will not be as strong as the record-setting levels we achieved in 2022. We expect the third quarter 2023 adjusted results will be similar to what we achieved in Q2 of 2022. I would note that third quarter adjusted results would exclude the impact of previously announced onetime trade case duties related to the company's import of products from Vietnam. Over the longer-term, our business is well-positioned to capitalize on the strong fundamentals in the repair and remodel, residential and commercial construction markets.
From a repair and remodel perspective, demand should be supported by aged housing stock in the U.S. where the median age of the home is over 40 years. And by U.S. move-up buyers trapped in their homes by legacy low interest rates and opting to improve their current residents. On the residential construction side, a decade of underbuilding in the U.S. combined with demographic changes where millennials are now the largest cohort should provide longer-term demand for housing. Commercial construction encompasses many sectors, including health care, education, public buildings, hospitality and recreational vehicles. Some sectors are showing strength, while others are recovering at a slower pace. We estimate that about 40% of our products end up in the repair and remodel end market, another 40% goes into residential construction and the balance into commercial and other.
This diversity positions us well to take advantage of these longer-term fundamentals. We have multiple channels to market, which includes industrial manufacturing, home center and pro dealer customers. We had a wide array of specialty products where no 1 product category exceeds 20% of our sales mix. And our size and scale offers competitive advantages being one of the largest distributors in the industry. In addition, we estimate our share of the addressable market to be 6%. We've outlined strategies with respect to capitalizing on these positive market fundamentals to achieve the company's Destination 2026 goals, which include run rate sales of $3.5 billion by 2026. Further details can be found in the December Analyst Day presentation that's posted on our website.
With that, I want to thank you for your time this morning. I'll turn the call back now to Joanna to provide instructions for the Q&A period. Joanna?
[Operator Instructions]. First question comes from Jeff Fenwick of Cormark Securities.
Rob, just wanted to circle back on your commentary there on the outlook. I appreciate the color about just the year-over-year pressures that are there. But I think some sequential improvement that you called out as well as we head into the third quarter here -- so what's your impression in terms of -- I know volumes can be a bit difficult to call, but it seems like maybe we're sort of leveling off through the big deceleration into a bit more of a normal environment. And I guess likewise, with pricing, it sounds like there's still a little bit of pricing pressure going on, but perhaps not quite to the same extent that we have through the end of the year.
Yes. Those are good questions. And it's always that balance people want to talk about year-over-year or sequential. I'll maybe focus more on the sequential. I would say, yes, I feel like we're entering into a little bit more of an orderly and maybe more predictable period, things around pricing industry capacity lead times for ordering product feel much more normalized. And we've got a demand profile, I think that's also settled down with hopefully fed tightening coming to an end and people's perspective on that. And we've seen some market forecasts come out recently that Fannie Mae in particular, are certainly much more favorable than they were coming into 2023.
So taking those things together, plus I would also mention the competitive dynamics where kind of channel inventories. Again, I would say, are more in the range of normal again, is making business a little bit more predictable and we like that. We have seen, I would say, through mid-year really a consistent month-to-month low single-digit decline in our overall product pricing suite. And we've been able to offset that with volume increases over the same period of time. So you heard in my comments that we're kind of looking at Q3 is probably looking quite a bit like Q2.
Okay. That's helpful. And then I wanted to sort of switch the focus here on working capital and inventory -- that also looks like it's reaching sort of maybe a more normalized level of days inventory that you got there and harvesting some cash from that. I mean, are you down around the level of inventory that you think is, again, back to normal? Or is there may be some opportunity to continue to harvest some cash from there as well?
Jeff, it's Faiz here. I can take that one. So yes, you're quite right. I mean we've done a lot inventory front. I mean in the last 9 months, we've taken out over 165 million inventory. As you mentioned, the days of inventories come down significantly as well. At the end of Q2 we've printed about 80 days of inventory. And you might remember on our previous conference call, I talked about that as being what we wanted to get [indiscernible] for this year. So we're sort of there on the . I would say the inventory right now is within the range -- and what you're going to see going forward is that inventory investment, if you will, or taking cash out of inventory would just be driven by the sales pace. As an example, the fourth quarter is typically the slowest quarter, right, in the building products industry. So going from Q3 to Q4, you could see a little bit of inventory come up, but it's really going to be driven by the sales pace through the remainder of the year.
That's very helpful. And I guess in that context as well, it sounds like supply chain is cooperating for you now and you're getting some benefit of that being a bit more normalized. I guess, linked to that as well as just transport and transportation costs. And I know it sounds like that's something where there may be some cost advantages coming your way from pricing falling away. So supply chain is easier around where you want with inventory? And then is there's a bit of -- maybe some rental savings just on transport costs...
Yes. Actually, I'm glad you raised that. When you talk about product price deflation, a component of that is the fact that we're selling a less expensive product because the embedded freight cost has been reduced. So about 1/3 of our products were sourcing from outside North America. So freight rates, container rates, in particular, you'll recall, in peak [indiscernible]. They've come down in the same way. So a component of our price -- product price deflation has been what you're raising that basically getting the product here has become more inexpensive. And so the embedded cost of that and what we sell has gone down. So -- from that perspective, we don't love that. We like to sell a more expensive product and have our pass-through margin on it.
The next question comes from Zachary Evershed at National Bank Financial.
Congrats on the quarter. So Rob, when you mentioned that the month-over-month low single-digit price declines are being offset by volumes. In your view, does that speak to a secular resurgence in demand? Or is it more in line with seasonal patterns?
Yes. I don't think I would go so far as to say there's a secular surge in demand. I think it's more of the latter.
Got you. And I think you've been clear on what's going on with working capital, so we'll skip that. But any update on how you're thinking about your capital structure and leverage comfort here?
Zac, Faiz here. From a leverage perspective, we talked about in that 2 to 3x, that's comfortable for us. We're at the top end of that range now. As Rob mentioned on the call, we've paid down a lot of debt in the last 12 months over $240 million, so they have been paid down. But you also have the -- which I'm sure you understand that the trailing EBITDA coming off of -- of records to a more normalized environment. So -- that's really what's driven the leverage up. We paid down a lot of debt and the EBITDA is maybe just rightsizing to where we are in the cycle for now. So that's 3x still comfortable for us, Zac, that's not a concern for us.
Just given that normalization, I talked about in the EBITDA, we're probably around 3x through the balance of the year. And then with the cash generation, it will start to come down again as you would expect from our business model. Again, barring an acquisition or something different there. So in the disclosures and the comments Rob made, when we talk about our capital allocation priorities here in the near-term, still being a focus, right, kind of a laser focus on paying down some debt. But those are the reasons why. But I would say the leverage is not in a comfortable place today.
That's good color. And then just one last one. Given the trend in pricing, inventory write-downs in the quarter were actually pretty good. Can you give us an idea of how you think they'll shape up through the back half of the year?
Yes. I think we're into a more -- this is the normalized business operating environment now. So I think we peaked out in Q4 at close to $7 million by memory, and you saw the number for the quarter. So I think what you saw in Q2 is going to be more indicative of going forward, maybe a little lighter. But the key point I would say is look at how much inventory we've taken out of the balance sheet and then absent just the dollars look at the days inventory on hand coming back down to more like an 80, it feels like a more normalized inventory and so write-down should be in the same -- within the same context.
[Operator Instructions]. Next question comes from Ian Gillies at Stifel.
As you think about the Analyst Day and the outlook at that time, I mean new home starts have clearly fared a bit better than I think you would have thought since that time. And it's hard to tell. I mean we all look at the same data, but has the R&R business been a bit weaker than you would have up this year?
Porting myself back to what I thought in December. I think -- yes, it's -- I mean it's been a little bit softer. And I only put it in the context of new res softness has probably hurt us more than softness in R&R and the commercial spend kind of a more of a for us. But as we look forward to -- we're already into planning for 2024, and we've got certain customers that have strong views on R&R being more positive going forward. And then when you look at the housing starts as well, while multi-families seem to be a little bit more disappointing from a forward-looking view, there's a little more optimism around singles in the U.S., which, as you know, are closer to 2/3 of the mix. So it is a bit of a moving view. I would say the way we think about the Destination 2026 is that run rate goal. That's still [indiscernible] years away. We very much indicated we were going to go through a data before we were going to have the recovery of build back and then a more active M&A component to getting to our goal.
No, that's fair. And then the other thing I was going to ask you about and it's more qualitative in nature is there seems to be emerging that more people are going to stay in [indiscernible] in the U.S., they're going to have to build more homes. And -- so there's going to be more R&R and more new home builds. You may not be seeing it today, but like how are you thinking about that and positioning the business and how it maybe impacts your business over the medium-term?
I mean we're much better positioned on the R&R front with having completed the Rojo and Mid-Am deals getting deeper into that pro-dealer and home center channel will allow us to participate in what may be more people having to renovate in place because they can't port their mortgages in the U.S. into a new spend. But I mean, I think the overall theme for us, which we've tried to emphasize in our communications. And then we've really tried to do as part of the strategy is just diversified. So we've got geographic product mix and customer participation in all areas of the architectural building products business, so we can benefit from pockets of strength when others may be on a relative basis a little bit weaker.
And then last one for me. If you work on the assumption that margins are flat from '23 to '24 -- or sorry, revenue is flat or maybe up a little bit. But can you maybe talk about some of the leverage you think you have to pull that get some EBITDA margin expansion, absent increases in activity?
Yes. Well, I think we are optimistic to Jeff's question that we're maybe reaching the end on some of the product price deflation. So that will be helpful. And then you can have volume gains, gain some traction as it relates to top line close expense management is going to obviously be a continued part of it. But you have to also look at the gross profit margin line. We made a significant improvement over the last several years, as you know, in GP percentage. And as we came out of the unusual conditions we faced the last couple of years, the question is where does that going to land? And we said, north of 20%. We've delivered that now for 9 quarters. And I'm pleased to see that we've got some sequential improvement between Q1 and Q2, I think there's more opportunity there. That's going to be part of the lever pulling that's going to get you back into the EBITDA percentage that's more in line with the Destination 2026 plan.
Thank you. At this time, I see no further questions.
Okay. Thanks, Joanna, and thanks to everyone on the line for joining us. Appreciate your interest in Adentra, please do call Faiz, myself, Ian, if you've got any follow-up questions or comments, and we wish you a great day.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.