ADENTRA Inc.

Good morning, ladies and gentlemen, and welcome to the Edentra Q1 2024 conference call. At this time, all lines are in 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 Thursday, May 9, 2024. I would now like to turn the conference over to Ian Tharp, Investor Relations. Please go ahead.

Thanks very much, Chris, and good morning to those joining today as we discuss Adentra's financial results for the first quarter of 2024. With me on the call are Rob Brown, Adentra's President and CEO, and Fez Karmali, Vice President and CFO. Adentra's Q1 2024 earnings release, financial statements, MD&A, and other quarterly filings 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 CDERplus at www.cdrplus.ca. I want to remind listeners today 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 the DENTRA'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'll now turn the call over to Rob Brown. Rob?

Hey, thanks, Ian, and good morning, everyone. Thanks for joining us today as we report Adentra's financial and operating results for the first quarter of 2024. I'll start with our key financial and business highlights for the quarter. Fez Karmali, our CFO, will then provide details of our Q1 financial results. I'll then finish off our prepared remarks with our outlook for 2024. We had a strong start to the year, with first quarter sales of $535 million, adjusted EBITDA of $45.6 million, and adjusted earnings per share of $0.78. Sales activity was solid in the quarter, with volume up lightly compared to the same quarter in the prior year. Overall, sales were lower than in Q1 2023 as anticipated, and this was due to product price deflation of approximately 9% year over year. In this environment, we still increased bottom-line results with adjusted EBITDA up 6% and adjusted earnings per share increasing by 18%. We accomplished this through an improvement in gross margin percentage to 22.1% in the quarter, 190 basis points better than in Q1 of 2023, and disciplined management of operating expenses. From a gross margin percentage perspective, Q1 marks the 12th consecutive quarter with growth margins above 20%, providing a sustainable level of profitability for our business that is supported by our strategic initiatives, including higher margin product mix gained through our acquisitions of Novo and Mid-Am, our focus on higher margin ready-to-install products, the positive contributions from our global sourcing program and our efforts to leverage data analytics and our digital platforms to better manage our assets and maintain strong discipline on our product price. Regarding operating expenses, in 2023, we reduced warehouse expense and headcount. These initiatives, combined with tight management of costs, helped to limit the increase in operating expenses year over year to just 1.5%. well below the rate of inflation. During the quarter, our business model continued to generate strong cash flow with 80% of our adjusted EBITDA converting into operating cash flows before changes in working capital. We invested some of this cash in working capital, which is normal for this time of year, but contrasts with the prior year period when we were actively reducing inventory levels. Our board also declared a quarterly dividend of 14 cents per share payable to shareholders on July 26th, 2024. Our balance sheet remains strong. Our leverage ratio exiting Q1 was 2.8 times, which is in our target range. And our unused borrowing capacity is over 445 million. I'll now pass the call to Fez to provide details of our Q1 financial results I'll return to talk about our outlook before we open the call to questions.

Thanks, Rob, and good morning, everyone. I'm going to recap our financial results for the first quarter of 2024 and outline our financial position at quarter end. Again, I'll remind those listening that any dollar figures Rob and I use today are in U.S. dollars, unless we've stated otherwise. Starting with consolidated revenue, regenerated sales of 535.1 million in Q1. This decrease of 44.7 million, or 7.7%, from sales levels in Q1 of 2023 was due to product price deflation and was partially offset by a 1% increase in year-over-year volumes. On a regional basis, sales in our U.S. operations were 492.5 million, or 8.2% less than Q1 2023. This was driven by a 9% decrease in product prices, offset by a 1% improvement in volumes. Our Canadian operations posted Q1 2024 sales of Canadian 57.5 million, which was 2.6% lower than Q1 sales in 2023. Canada experienced the same 9% decrease in product prices, which was partially offset by a 6% increase in sales volumes. Moving now to gross margin, we earned $118.2 million in the first quarter, a 1.1% increase as compared to Q1 2023. This change mainly reflects a gross profit percentage of 22.1%, which was an improvement of 190 basis points over the gross margin contributions in Q1 2023, partially offset by the lower revenue. The factors supporting our improved gross margins include the strategic initiatives Rob outlined at the start of the poll and lower inventory write-downs as compared to the same period in the prior year. Out-operating expenses for Q1 were 93.8 million, a 1.4 million or 1.5% increase compared to Q1 of 2023, primarily driven by continued inflationary pressures in the economy. Looking now at our adjusted EBITDA, for Q1 2024, it was 45.6 million, or a 6.3% improvement over the first quarter of 2023. The main drivers of the adjusted EBITDA improvement were the increase in gross profit of $1.2 million and a $1.4 million reduction in operating expenses before changes in depreciation, amortization, and out of expense. And finally, adjusted net income in the first quarter was $17.3 million, an increase of $2.5 million, or 16.8% over Q1 of 2023. The change was primarily driven by the $2.7 million increase in adjusted EBITDA and a $1.1 million decrease in finance expense, partially offset by $1.3 million in additional depreciation and amortization expenses. On a per share basis, adjusted profit per share was $0.78, which was an 18% increase over the $0.66 posted in the same period in the prior year. Looking at our cash flow position for the first quarter, we generated 6 million of cash flows from operating activities as compared to 69.8 million in the Q1 period in 2023. The year-over-year decrease was the result of Q1 working capital investments of 30.8 million compared with a 39.8 million cash inflow from the release of working capital in Q1 of 2023, which was a period where we were actively reducing our inventory levels. the investment in working capital is normal for this time of year. Moving next to our balance sheet, our cash flow generation in Q1 was primarily used to fund our investments in working capital as mentioned. And our net bank debt at the end of the quarter totals 397 million. We ended the quarter in solid financial position with a leverage ratio of 2.8 times and unused borrowing capacity of over 445 million. which provides us with the flexibility we need to fund future growth and advance our business strategies while managing any short-term headwinds. Our capital allocation priorities are the continued responsible management of our balance sheet, funding our growth through acquisitions as well as organically, and providing incremental total returns to shareholders. With that, I'll hand the call back over to Rob. Rob?

Great, thanks, Fez. I'll wrap up my prepared comments today with our outlook and details on our strategy to continue building the long-term value of Edentra. As we progress through 2024, we expect that the combination of inflation and elevated interest rates will have moderate impacts on economic activity. We expect residential construction to show stable levels compared to 2023, and stable to lower levels in the repair and remodel market. These segments each represent approximately 40% of our sales. Sales volumes stabilized in the first quarter, and we continue to see some softness in product pricing. We anticipate that year-over-year sales comps will improve in the latter half of 2024. Our outlook is for modest growth in 2024 adjusted EBITDA through our focus on strong gross margins and tight management of operating expenses. In addition to continued strong operating discipline, we're focused on the execution of our Destination 2028 plan. The plan includes acquiring $800 million in run rate revenues by 2028. We're one of the largest distributors of architectural building products in North America, with approximately a 6% market share. We have a robust acquisitions pipeline and there remains a significant opportunity for growth in this fragmented market. Our business is also well positioned to capitalize on the fundamental demand drivers in the repair and remodel and residential construction markets over the long term. These drivers include positive demographic factors, an aging U.S. housing stock, strong home equity levels and the continued underbuilding of homes in the United States and Canada. Future decreases in interest rates could further support end market demand for our products. With that, I want to thank you for your time this morning. I'll now turn the call back to our operator, Chris, to provide instructions for the Q&A period. Chris?

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star, followed by one on your touch-tone phone. You will hear a three-tone prompt acknowledging your request, and your questions will be polled in order that they are received. Should you wish to decline from the polling process, please press star, followed by two. If you are using a speakerphone, please lift the handset before pressing any keys. One moment, please, for your first question. Your first question comes from Yuri Zoraida, Canaccord Genuity. Yuri, please go ahead.

Good morning, guys. Nice quarters. Hey, so if I could just perhaps start with volumes, they continue to hold, and as you were mentioning, you're expecting the residential markets to remain stable in your outlook. So given that rate declines are taking longer and housing data has been a little bit volatile, Just wondering, is there any science or data that could give confidence on volumes remaining stable in the back half of the year?

Yeah. So, I mean, we were quite pleased, I would say, with the first quarter. And to your point, the volume stability that we saw year over year, pricing obviously is is a headwind. You know, absent seeing something change, that's, you know, our expectation going forward. You pointed out the residential being stable, you know, peeling that back, there's different trends within single family and multifamily, of course. But I think the encouraging leg of that is, you know, seeing some growth in single family as probable for the current year. But yeah, like you, we keep a close eye on the housing market and it's been a little bit choppy in the short term, but we just remain focusing on what we can control, executing our business, continuing to put up good results around margin and cost control. And again, as I mentioned at the end of my prepared remarks, the longer term fundamentals for demand for our products is very positive.

Okay. Yeah, that's very helpful and good color. In that vein, on gross margin, they were higher year-on-year and sequentially despite the challenging environment, which was very nice to see. I understand A lot of that comes from mix with recent acquisitions and the strategies you've been implementing. But I'm just wondering if you could provide a little more color on any other drivers that could be behind that trend specifically for the quarter.

Yeah, I mean, we feel really good about that. It was an important element delivering the result we did in the quarter with some growth in scenarios and EPS. The strategy piece, I mean, the mix is there with some of the businesses we've acquired. We continue to also, unfortunately, add products we describe as more margin resilient, you know, where we've got either exclusive or semi-exclusive distribution rights in a territory, decorative surfaces type products. But then the things around the strategies, you know, I also mentioned in my prepared remarks, digital, the use of data analytics around just getting better at pricing, and that we continue to improve upon, and I think that's also been a solid contributor to the results that you saw.

Okay. Thank you, and congrats again, and I'll turn it over.

Thank you. Your next question comes from Jonathan Goldman, Scotiabank. Jonathan, please go ahead.

Hi. Good morning, guys. Thanks for taking my questions. Maybe just coming back to the gross margin conversation, maybe trying to ask it a different way. Do you see the mix evolving dramatically quarter on quarter or through the year, however you want to discuss it?

Yeah, it's always good to take a run at it. question with different words when I don't give a good enough answer, Jonathan. I appreciate that. Look, on the margin, you're right. It's year-over-year improvements, sequential improvements, very positive, and I really would say a lot has to do just with our sales force being very disciplined as they go to market, and we've given them better abilities to understand what products are more price sensitive versus less price sensitive and to make pricing decisions accordingly. We're comfortable with the levels that we're at today. We don't kind of see that as being outside of a range that we can sustain over the next number of quarters. I would say it's at the higher end of the range than our expectations would probably indicate. But there's nothing I see on the immediate horizon that should kind of change the landscape for how we're managing the margin.

Okay, that's good color. And I guess maybe drilling down on that a bit, are any of your digital initiatives actually enabling that pricing discipline and how it's coordinated with the sales force as well?

Yeah, very much so. We've discussed an e-commerce footprint that is not typically the case in our industry. I wouldn't say that most of our competitors that has invested in this area. But when you do and you create that offering, if you're going to do it effectively, you have to have very well-coordinated operational information around what's in your warehouse. And then you need to price it because all accounts have different characteristics that drive different pricing that attaches to them. So having the digital or the e-commerce platform forces you to be very thoughtful about how you go to market with pricing. So the two go hand in hand.

Perfect. Thanks for the idea. I guess skipping to the top line. The Q2 guide, I think it calls for sales applying similar to Q1, so down 8%. Would the composition of that decline also be similar to Q1 in terms of price and volume?

Hey, Jonathan, good morning. It's Ezra. I can take that one. I think that would be a fair assumption. You know, in terms of the product pricing trends that we've been talking about for a couple quarters now, I would say that, you know, that continued through Q1 and as you would expect even into April here. So that kind of, you know, sequential basis, month to month to month, kind of that one to 2% softening in price. So if you just did the math on that, you'd get a similar result for, you know, for Q2 in terms of your volume versus price mix. The volumes, I think as Rob mentioned, and as we stated in our materials, I thought we're encouraging in the first quarter. You know, it's the first time in a number of quarters where we actually had a bit of volume growth. So the volumes feel stable, but the product pricing is where we'll see some leakage again year over year, and Q2 would be the expectation.

Okay, perfect. Thanks for the call, guys. We'll turn over the line.

Thank you. Your next question comes from Hamir Patel, CIBC Capital Markets. Hamir, please go ahead.

Hi. Good morning. Rob, if you look at your various product categories, are you able to share which of the products have negative pricing comps still, if any have been selected positively already, and just any more visibility on pricing by category? Okay.

I mean, we obviously have some visibility over that from here. I don't think there's a nugget or a big insight that I can give you on this call. However, I mean, we've got 175,000 SKUs and we're in a dozen major product categories. My comment would be for the most part, we don't have anomalous product categories. Most are moving kind of in lockstep. They're not all identical, but I don't think I would you know, point to one and say it's radically different than another.

Okay. Fair enough. And, Rob, just on the volume front, are you able to comment on how volume is shared by channel in Q1, just thinking sort of R&R versus URES or multifamily?

Yeah. I mean, one way to think about it is, you know, how we manage by customer channel here is, the home center and pro dealer customer category versus the industrial category, relatively similar. Like I would not say, yeah, we're kind of hitting it out of the park in one and really lagging in the other. I think it's indicative of overall movement in the economy as opposed to something being way off or outperforming. If we had that, I would call it out.

Fair enough. Thanks, Rob. That's all I had. I'll turn it over.

Thank you. Your next question comes from Zachary Evershed, National Bank Financial. Zachary, please go ahead.

Thank you. Good morning, everyone. Congrats on the quarter.

Hi, Zach.

So in terms of an update on the M&A pipeline, do you expect anything to cross the finish line in the first half of the year, or will it be more of a back half in future years story?

Where are we? We're mid-May. I probably wouldn't parse it over the next six weeks versus seven, eight months. I would say I'd be surprised and disappointed if we don't get something meaningful done over the course of the year. We've got things that are active, but with M&A, there's never a guarantee. So, Nothing to really say about Q2, but you should feel good about the level of activity we have underway and discussions as it relates to getting back on track with some acquisitive growth in the year, and that's supportive of what we want to do with the destination 2028 plan, as you know.

That's helpful. Thanks. And then you did mention that mix was at the higher end of the range of your expectations. And we think about gross margins being very attractive at 22%. Would you call anything out in the quarter that kind of artificially drove that up that you might have to give back?

The short answer is no, no, nothing of that nature.

And how are gross margins trending so far in Q2 now that we're in mid-May? Okay.

I think we're steady. So, you know, again, another probing question on gross margin. You know, we don't have any kind of mid-course corrections around that to report out at this point. We've kind of continued on our way into Q2, and you just saw the Q1 numbers. Thank you.

Then on your value-add products, I always think about pre-hanging doors in that category. But could you give us some more examples of installation-ready products or any innovations that you're working on there?

Yeah, I mean, the doors and finishing millwork is the big one. We do very well with that. We will also do custom molding packages for specific house projects. Increasingly, you'll sell on the home center side a product that is as consumer-friendly as it can be. So, you know, where you may have used to have sold something that was primed and ready to take paint, you're now selling a paint product in many cases that's just ready for install and accompanied by, you know, mail and touch-up paint to assist a consumer with kind of finishing a job on their own. So it's that kind of continued evolution that And it's very helpful, I think, to our customers in that skilled labor at the final mile at the job site is sometimes more scarce than it used to be. So the extent that we can provide a product that requires the least amount of kind of installation adjustment or expertise, the better. And we're happy to do that service and we get paid well to do that.

Great color, thanks. And that last piece I think is a good segue to my final question here. Builders First Source had commented that early stage construction materials are moving quickly, but finishing touches haven't seen a pickup yet. Are you seeing any indications that construction times for new res are starting to blow out again?

Yeah, I don't know about the specific lead times, so I won't comment on that specifically, but I would echo your comment around we're seeing our pro dealer customers shipping a lot of housing, like a lot of framing packages out. And of course, you know, finishing molding and stair part and other kind of millwork materials that we provide in the finishing stages follows that. So, you know, that comment is encouraging from BFS. They're obviously an important customer to us as well.

Great, Claire. Thanks. I'll turn it over.

Thank you. Ladies and gentlemen, as a reminder, should you have a question, please press star 1 on your touchtone phone. Your next question comes from Ian Gillies, Stifle. Ian, please go ahead.

Morning, everyone. With respect to the M&A pipeline, there certainly seems to be more optimism there. Is it a function of... more private equity packages coming to market or some of the, I guess, companies in your proprietary pipeline that you've built over the years, are they just coming closer to a point where they want to sell or is it a mix of the both?

Yeah, so those are more supply-driven comments and I'll invest that, I would say, on the more of the demand-driven, like what are we doing? We just, we had some things we needed to take care of last year as as you know, around inventory drawdown and repaying debt. So while I won't say we weren't on the sidelines, we were more in maintenance mode with a number of our discussions. We feel like we could play some more offense now, having taken $220 million out of the balance sheet on the debt side last year and feeling really good about where our days on hand in terms of inventory is now. we're kind of ready to go. The other thing that is important is a little bit more predictability around market conditions and results. We kind of feel like we know where we're at. We have a quarter that just came in where we thought we'd be at. So all those things just give us more confidence in terms of getting more active on M&A. You're probably picking that up in the commentary. On the supply side, I think The same is true to a certain extent where other participants, people that we might want to acquire, were doing some of the same things last year, getting their balance sheet in order, figuring out where demand for their business was going to be after a number of years that were fairly unusual. So all that kind of stability, I think, on both the buy side and the sell side makes it more attractive for us. What's good is that we've had the resources in place the whole time and we've been doing the work. So it's easy to pick that up and start moving forward again.

Got it. That's helpful. And following on that question, perhaps in a bit of a different way around product mix, is there any particular product that your customers are asking more of you that you wish you had more access to? or maybe even products outside of your existing mix that you wish you had access to today?

There's always new opportunities in the product set. You know, we found our way into new opportunities with, uh, well, going way back with rugby into doors, the acquisition of Novo into, uh, stair parts and, uh, boards and, and, uh, no work, uh, in a more meaningful way. And then if you look at Mid-Am, they have a very wide line card. So all those things are giving us a taste and access to new product categories. And we are thoughtfully doing some cross-selling of those things from one brand into another. And we really view it as wanting to continue to build that one-stop shop solution for our customers. that they're very busy people. They operate busy sites and locations, and they don't need six trucks arriving. They need to be unloaded and logistically managed when they can get their needs unwanted. So we continue to move more towards that type of model.

Okay, that's helpful. I'll turn the call back over and save my gross margin questions for the next call.

Thank you. There are no further questions at this time. Please proceed.

Okay, great. Thanks, Chris, for hosting today, and appreciate everybody's questions. Fez and I are always available, so do reach out if you've got some follow-ups, and we'd be happy to take your call. Everybody have a good day, and appreciate your interest in the company.

Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.