ADENTRA Inc. (ADEN) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Adentra Fourth Quarter and Year-end 2022 Results Conference Call. [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.

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 dollar figures referred to today are in U.S. dollars unless stated otherwise. I would now like to turn the call over to Rob Brown. Rob?

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 a 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 taken 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 rebranding 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 have advanced into 2023, we've also -- we're also excited to have established 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?

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 use today are in U.S. dollars, unless we 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 a $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 a $3.2 million unfavorable FX effect 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 $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 CAD 57 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 a 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, which is a 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 deal of 2.4x 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 acquisition-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'll turn the call back over to Rob. Rob?

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 have 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 at 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 the 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's questions. So I'll turn it back to Michelle to provide instructions for the Q&A period. Michelle?

[Operator Instructions] First question comes from Hamir Patel of CIBC Capital Markets.

Rob, $8 million 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?

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 $2 million. 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 we'll continue to run at that type of rate.

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

So I probably won't go category by category. It'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 continue 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.

Okay. Great. Just a 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?

Hamir, yes, I think there's -- what I would say is if there is a final determination at the end of March that required some duty payments. We would likely be to accruing it. In terms of payment, there's a couple of different layers to work through there. You may not 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 into accruing it in Q2, so it was a final determination that said 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've put out a deadline and then chose to delay it. So we're into a number of iterations now on time lines. The current time line 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.

I'd just throw in a couple 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 to that range as well. You 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 view that we disagree and would pursue all angles on appeal. We feel very strong we've got good documentation that can support that our product should not be included in this ruling. But that would be a fight that would take some time looking at it.

The next question comes from Yuri Lynk of Canaccord.

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 in 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.

No, yes, 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 end up with a daily sales pace. Comparing that daily sales pace to what we saw in January plus February, they were about flat, about the same.

Okay. I just want to make sure. That's helpful. Second one for me, just on 2, 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. But 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 went from one to the other, not sure.

Yes, Yuri. On your first question, in terms of variability to expenses or maybe just to speak about total expenses, I mean there's some variable components in both those lines. But at a high level, about 70% of our expenses relate to people or premises costs. So rents, overheads associated with your premises, et cetera. So in the short term, there's, 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's some flex in there, but I would say a 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, those are more fixed. You're going to have things like travel, marketing expenses, trade shows, those are going to be a lot more variable. So there's a bit of a mix, a mix of maybe fixed and what I'd like to describe as semi-fixed, again on some of those things, you can do things over several quarters, maybe not necessarily quarter-to-quarter though. On your second question, Yuri, yes, in Q4, we did do a bit of a reclass between those 2 expense line items. Just to do some cleanup and aligned with how we're thinking about the business. So I can walk you through offline, but there was a reclass that you described between those 2 lines just relating to the fourth quarter.

[Operator Instructions] The next question comes from Zachary Evershed of National Bank Financial.

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

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's purpose by behaving more erratically on pricing. I think as you get closer to the finish line where people have rightsized 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 getting relatively close to the balance.

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

So I mean, there was a couple of things that went on with margin. You saw in the write-down, which we've discussed, and you can kind of add that back and get into the mid-21%. So what we've always emphasized is that we've reset the business above 20%. We're there 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 midyear, 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.

Got you. 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 they're 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 takeout?

Yes. So we did get a modest tuck-in done in February ourselves, and that was done at a very favorable multiple. So there's still deals that you can accomplish. We're active in our conversation. I think that it's really more on 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 in 2023. And so it's really more around that what's the sustainable EBITDA number that's the conversation in -- looking at each of these M&A opportunities. But I, for one, think we will continue to see good opportunities in front of us that are transactable 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 I'm on 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.

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

Sorry, I missed that, Zach.

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

It's been a bit of a mix. There's certainly been more activity on the political logging side, I guess, for lack of a better word, where there's been a number of mainstream members of Congress who have 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.

The next question comes from Ian Gillies of 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 has been performing so well -- performing this year?

Yes. So on the -- 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 midyear.

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?

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.

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

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 I appreciate you joining the call today.

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.