ADENTRA Inc.

Good morning, ladies and gentlemen, and welcome to Adentra's first quarter 2023 results conference call. At this time, our lines are in a listen-only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded on Friday, May 12, 2023. I would now like to turn the conference over to Mr. Ian Tharp, Investor Relations. Please go ahead.

Thanks, Lara, and good morning to those joining today as we discuss Adentra's financial results for the first quarter of 2023. With me on the call today are Rob Brown, Adentra's president and CEO, and Fez Karmali, vice president and CFO. Adentra's Q1 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 a dentist's profile on CDAR at www.cdar.com. I want to remind listeners that management's 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 Edentra's earnings press release and financial filings for 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. I am pleased to speak with you this morning as we report Edentra's financial and operating results. for the first quarter of 2023. I'll start with our key financial and business highlights for the quarter. Fez Carmeli, our CFO, will then provide details of our Q1 financial results. I'll finish off today's prepared remarks with our outlook for 2023. We generated $580 million in sales, $43 million in adjusted EBITDA, adjusted earnings per share of $0.48, and 70 million of cash flow from operating activities in the quarter. As described in our previous outlook, rising interest rates were expected to reduce demand for architectural building products in the near term. We anticipated reduced financial performance in 2023 as compared to the record setting levels achieved in 2022. First quarter results were in line with this expectation. Organic sales decreased year on year by 13.8%, primarily driven by lower volume demand as compared to the record-setting pace in 2022. Lower organic volume demand was partially offset by a 4% sales increase contributed by acquired businesses, such that total sales were down by a lesser 10%. Gross profit percentage also performed as expected, coming in at just over 20% for the quarter. were well controlled despite continued general cost inflation that persists in the economy. Despite the impact softer demand conditions had on sales and bottom line earnings, cash flow from operations was strong and increased by 100 million year over year. We demonstrated the business's ability to generate significant cash flows during periods of reduced economic activity. 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. We put the substantial cash flow generated during the quarter to work, financing the purchase of Roho distributors, repurchasing almost 2% of our outstanding shares, announcing a quarterly dividend of 13 cents Canadian per share, and paying down net bank debt by $43 million in the first quarter. As we move forward, we will continue to closely monitor changing economic conditions and the impacts of recent inflation, rising interest rates and other factors that can have an effect on our business. I'll return to speak more on our outlook later on, but I'll now pass the call to Fez to review the Q1 2023 financial results in more detail. Fez?

Thanks, Rob, and good morning, everyone. I'm going to provide the details of our financial results for the first 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 $579.9 million in Q1, which was a decrease of 10.1% or $65 million compared to the first quarter of 2022. Organic sales decreased by $88.7 million or 13.8%, primarily reflecting lower volumes. This was partially offset by a $26.4 million or 4.1% increase in Q1 sales sourced from acquired businesses, which include NINAM acquisition, which we closed in February of 2022, as well as Roho distributors closed in February of this year. Also contributing to the Q1 decline in sales was a 3 million unfavorable FX impact due to the translation of our Canadian sales to US dollars for reporting purposes. Focusing regionally, sales in our US operations were $536.2 million, which was 9.3% lower than the corresponding quarter in 2022. Organic sales in the US decreased by $81.7 million, or 13.8%, as compared to Q1 of the prior year, and this change was largely volume driven. This was partially offset by increased acquisition-based sales from MidAm and Roho of an additional $26.4 million. In Canada, Q1 sales were Canadian $59.1 million, which was 13.2% lower than the same period in 2022. Similar to the US market, the decrease in Canadian sales primarily reflects lower volumes. Turning to gross profit, we earned $117 million in the first quarter, a 20.8% decrease as compared to Q1 in 2022. This change reflects lower organic sales and a gross profit percentage of 20.2% as compared to 22.9% in the same period last year. Our gross profit percentage in the prior period was temporarily elevated due to favorable market dynamics, including strong demand and tight supply. Our operating expenses for the first quarter of 2023 were $92.4 million, or $7.7 million higher than Q1 of 2022. $4.3 million of this increase related to incremental operating expenses and intangible asset amortization from our acquisition of MidAm. And we incurred 3.4 million in organic cost increases. I would note that despite higher inflationary conditions prevalent in the economy, the incremental organic expenses represents just a 4% increase as compared to the same period in the prior year. Moving now to adjusted EBITDA. For Q1 2023, it was $42.9 million, a decline of 46% that was primarily driven by decreased Q1 gross profit margins and the increase in operating expenses I mentioned earlier. As a percentage of sales, our adjusted EBITDA margin was 7.4% for Q1 of 2023 as compared to 12.4% in Q1 of 2022. Finally, Q1 profit was $9.6 million, a decline of $33.9 million from the same period in 2022. This change was driven by the reduced EBITDA mentioned earlier, increased depreciation and amortization of $1.8 million, and $6.8 million of additional finance expenses offset by an $11.4 million decrease in income tax expense. On a per share basis, basic profit was 43 cents in the quarter as compared to $1.83 in Q1 of 2022. Looking at our operating cash flow for the quarter, this increased 100 million to 69.8 million year over year. Of this amount, 49.1 million was generated from the reduction in inventory levels in the first quarter. Moving next to our balance sheet, our strong cash flow generation enabled us to reduce debt by a total of $49 million, bringing the amount of debt we have repaid in the past year to a total of $213.7 million. We exited Q1 in a solid financial position with a leverage ratio of 2.6 times and unused borrowing capacity of over $325 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 our organic and acquisitions-based growth, and providing incremental total returns to shareholders. As outlined during our Q4 2022 results call, in February of 2023, we completed our small token acquisition of Texas-based contributors as part of our ongoing M&A efforts. With respect to returns to shareholders through a combination of dividends paid and share repurchases, We returned a total of $11.4 million to shareholders in Q1 of 2023. With that, I will turn the call back over to Rob.

Rob? Thanks, Wes. 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 that previous inflation and increases in interest rates will have a negative impact on economic activity. In turn, this is anticipated to result in reduced organic product demand and could lead to softer product pricing and volumes as compared to prior periods. As a result, and as we experienced in the first quarter, we expect our financial performance in 2023 will not be as strong as the record-setting levels achieved in 2022. With that being said, we remain confident that our business continues to be well positioned to weather the more challenging market conditions expected in 2023. As we outlined in detail during our analyst day last December, over the past two years, we've significantly grown and broadened our market access. Our end market participation now gives us strong access to customers in the residential construction, repair and remodel, and commercial sectors. Our 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. The scale of our platform combined with our broad end market participation, expanded channels to market and diverse product mix are valuable sources of stability for our business model. And we believe they reduce our exposure to any one geography or segment of the economy. And as demonstrated over the last several quarters, our business converts a high proportion of EBITDA to operating cash flow before changes in working capital. In periods of reduced economic activity, our ability to release working capital is an important additional source of cash. We also maintain a strong balance sheet and over $325 million of undrawn liquidity on our credit facilities. Over the longer term, we expect demand for our products to remain robust, supported by strong fundamentals in the residential, repair and remodel, and construction markets. These fundamentals include high levels of home equity in the US, a median home age of over 40 years, Housing starts having meaningfully lagged population growth over the last decade and positive demographic factors driving the demand for living spaces. In addition, we estimate our share of the addressable market to be 6% and we've outlined and remain focused on pursuing our destination 2026 goals to achieve run rate sales of 3.5 billion by 2026. Further details of this can be found in the December Analyst Day presentation on our website. With that, I want to thank you for your time this morning. I'll now turn the call back to Laura to provide instructions for the Q&A for today. Laura?

Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session. If you have a question, please press star followed by the number one on your touchstone phone. Again, that's star followed by the number one on your touchstone phone. If you would like to withdraw your request, please press star followed by the number two. Please stand by while we compile the Q&A roster. Your first question comes from the line of Gabriel Nicholson from CIBC Capital Markets. Please go ahead.

Hey, everyone. Hope you're doing well. Hi, Gabriel. In the press release you mentioned pricing was stable year-over-year. I was just wondering if you could provide some more color in terms of sequential changes as well as any changes by product category.

Yeah, I think it'll be probably a little bit disorderly to go through all the product categories, but on a sequential basis, it's a good question. We've generally seen very low single digit month over month changes in pricing where it's been declining. We've been putting volume gains on the board of a similar amount. So all in all, flattish as we've kind of moved through the first quarter.

Okay, great. And then second question, how is the M&A pipeline looking and have you seen any change in vendor expectations?

M&A Pipeline is quite active. As always, we've got a number of conversations ongoing, but I would describe some very good opportunities available to us. It's hard to make a generalized statement around seller expectations. I would say there's a general recognition that building product companies have just enjoyed an extremely good period of demand and success. And there's more reasonable expectations in terms of people understanding what sustainable EBITDA is and that pricing is based off that kind of a perspective. So we still feel very good about the activity levels we've got. As you know, this is a fully staffed resource and a critical component of our Destination 2026 plan. So we intend to continue to be active.

For sure. Okay, thank you. I'll get back in the queue. Thanks.

Your next question comes from the line of Jeff Fenwick from Cormark Securities. Please go ahead.

Hi. Good morning, everybody. So, Rob, I just wanted to start my questions here on the gross margin front. You've held steady, I guess, for a couple of quarters now, and I think in the past you've spoken to the shift in the product mix from M&A helping you stay above that 20 level. Is there much in the way of shift in the mix in inventory that might influence the gross margin at this point? Or is it just broadly the pace of change in pricing that you're seeing that might move that up or down?

No, I don't think we would call it anything on the mix in inventory. We are pleased that we're holding above the 20%. That's part of our target financial KPIs, again, in that destination 2026 model. You're right, the M&A has helped with the overall product mix, but we also have done some things around better pricing discipline. The mix of import versus domestic products in our overall offering are also contributors to what I would say is a more fundamental or long-term shift in the margin to keep that above the 20%. I would say that in the first quarter and also in the fourth quarter, We had what I would describe as generally a little bit higher inventory write-downs, which put a little bit more pressure onto the margin. But despite that, as you noted, the last two quarters have been at the 20.2%. Thank you.

That's helpful. And then obviously nice to be able to harvest some cash out of working capital. Where are you now in terms of the positioning there? Is there much incremental to do? And I guess maybe there's some seasonal considerations here too. I tend to think about sometimes a bit of a seasonal build in inventory as well as you head into the mid part of the year. What's the situation there?

Yeah. Hey, Jeff. It's Fez here. I can take that one. I mean, you kind of highlighted it. In the last six months, we've accomplished quite a bit on the inventory side. I mean, the days on hand have come down as noted, but You know, we took out almost $50 million in the first quarter here. We took out just over $80 million in the fourth quarter of last year. I've talked before about our goal wanting to be kind of by the end of this year, that 80 days, plus or minus. So we're getting there. We're sort of in the mid-80s now. I think there's a little more we can do still in the inventory, to your point. I'm not sure we get a lot of that in Q2 or Q3. That might be more of a back end of the year thing. But I think there's, you know, at current sales pace, there's a little more we can do on the inventory. There could be another, you know, to go from 85 to 80 days at current sales pace, that could be another 40 plus million dollars of inventory. It's probably in the back half of the year, but I think there's a little more we can do there as well.

Okay, great. And then maybe just one last one here. Just trying to get some context around seasonality versus the broader cycle that's playing out. And Q2 tends to be seasonally better for you. And you think that's still the case this year where you could see a sequential tick up in revenue, you know, despite some of the headwinds on pricing and demand.

Yeah, I think you're right. It is a little different just with the broader cycle to say how does that, you know, cross-reference against regular seasonality patterns. Yeah, I mean, we certainly are looking for an uptick as between Q1 and Q2 and carrying through Q3. As you know, Q4 is a softer period of time. It's a little early to say, I think, how that's going to play out, you know, in reference to my previous response to, I think, Gabriel's question. We're seeing a little bit of pricing leak month over month, but we're making volume gains month over month. So I think we need to let that play out just a little bit more.

Great. Okay, that's all my questions. Thank you. Thanks.

Ladies and gentlemen, just a reminder, should you have a question, please press star followed by the number one on your touchstone phone. Your next question comes from the line of Zachary Ebershed from National Bank Financial. Please go ahead.

Good morning, everyone. Congrats on the quarter.

Hi, Zach. Good morning.

Given what you're seeing in terms of end market demand with volume sticking up and pricing leaking quarter to date, where do you see gross margins going from the Q1 level?

I think the general question. statement that we've made that they'll be north of, they'll start with a 2, they'll be north of 20 as our goal is unchanged at this point, Zach, and we've been running there, as mentioned, the last couple quarters despite taking quite a bit of inventory out of the system.

Got you, thanks. And how are you evaluating operating leverage at this point? Are you looking to cut costs to continue to maintain EBITDA margins or would you rather maintain the structure for the eventual bounce back?

Yeah, I mean, there's certainly leverage in the P&L. We enjoyed that on, you know, the extremely strong demand we saw in 2022. And, you know, we're seeing the other side of that, obviously now with less volume demand. We're always attuned to being very disciplined on costs We've got, as you would expect, certain cost controls in place given we're facing lower volumes right now. Having said that, we're not making a structural shift where we are making a major capacity reduction because we see brighter times ahead. When you think of the longer term outlook that I described in my opening statements, that longer term is not that far away. In our perspective, that's quarters. quarters away, so maintaining productive capacity as it relates to people, it's still a very competitive labor market, and having the facilities, the physical capital to move product is still very much on our agenda. But I, again, qualify those comments with, yes, we are being very disciplined on the judgmental spending and things that we can control in the shorter term as we do go through a little bit of a softer demand period.

Great answer. Thanks. I'll turn it over.

Thank you. Your next question comes from the line of Kiran Mamtoora from BMO. Please go ahead.

Thank you for taking my questions and good morning. First question, Rob, I'm curious, you know, within sort of your end markets of, you know, new resi, repair and remodeling, commercial, can you talk to at all kind of what the trends were during Q1 and what you've seen so far in April and sort of, you know, through kind of middle of the May? Are you seeing any signs where new resi seems to be stabilizing, maybe, you know, getting a little better? Just curious, you know, kind of how they are trending in the last few months.

Yeah, great question, Keaton. So I think what we would say on R&R versus residential versus commercial is it lines up probably reasonably well with what we put in the outlook statements where R&R has been a stronger performer. Residential, you know, less so. We're obviously running at about 18% to 20%. less starts if you wanted to pick a metric than we were a year ago. And commercial, we've got, it's been quite steady. So, you know, on the residential, we read all the same stuff you do. We read your stuff too. You know, I think that there's some green shoots there in terms of what home builders are seeing for future orders. That really hasn't filtered through to us yet because our products are in the finishing stages, but we certainly keep a close eye on that for, you know, future demand and view it as positive.

Understood. And on the commercial side, Rob, is there sort of any signs of, you know, market activity easing at all or it's sort of it is what it is at this point?

I would say the latter. I mean, it just, it feels steady. You'll recall we have a separate Specification Salesforce, referred to as Design OneSource. You can check that out online at designonesource.com. The reason I bring them up is they call on architects and designers to create future demand for our product, pull through demand by getting proprietary products we have written into future construction specs. On that front, they're very active. and the number of projects that we're tracking continues to grow. So, you know, right now I think commercials, as we've said, kind of flattish, but when we look at things that we've got in the pipeline for future, we feel good about that segment as well.

Got it. That's helpful. And then one for Fez, curious, you know, how, how you think about, you know, sort of approach towards share repurchases to the extent that, you know, this macro uncertainty, you know, provides any short-term sort of dislocations. And I know you talked about the M&A pipeline being quite active. So how do you balance sort of, you know, your interest to, you know, kind of grow via M&A versus opportunity for share repurchases in the broader context of leverage?

Yeah. Hey, Keaton. I would say our capital priorities are to grow the business. M&A is a very important component of that in our destination 2026 targets and that information for those listening can be found on our website and our analyst day materials from December. Keaton, you're of course, you've seen those. You know, our plan to get to 3.5 billion in run rate sales by 2026, a very large component of that is M&A focused. That's really, you know, between that and managing leverage, that's really the focus of our capital allocation. Beyond that, we're maintaining the dividend today. And then we've really taken a measured approach to share repurchases. So I would say going forward, the balance sheet leverage, one, and our opportunities for M&A. And then, of course, just, you know, or funding organic growth. Those things are really the priority for capital. And I would describe maybe share repurchases as coming after that. So As Rob mentioned, in our M&A pipeline, there's very good activity right now. Even in this environment, there are deals that we could potentially do that are accretive. And so if that's available to us, that's going to be the focus.

Got it. Now that's very helpful. I'll turn it over. Good luck. Thank you.

Thank you. There are no further questions at this time. I'd now like to turn the call back over to Mr. Rob Brown for any closing remarks.

Okay, thanks, Lara, and thanks, everyone, for joining us today. Appreciate your interest in Edentra. Please do reach out to Fez or myself or Ian if you've got questions or follow-up comments, and thank you again. Have a great day.

Thank you, sir. Thank you so much, presenters. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.