Doman Building Materials Group Ltd.

Greetings and welcome to the Dome and Building Materials Group second quarter 2023 conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ali Madhavi, Investor Relations. Thank you, Ali. You may begin.

Thank you, Operator, and good morning, everyone. Thank you for joining us this morning for Doman Building Materials' second quarter of 2023 Financial Results Conference call. Joining me on this call this morning are the company's Chairman and Chief Executive Officer, Amar Doman, and Chief Financial Officer, James Cote. If you have not seen the news release which was issued after the close of market yesterday, it is available on the company's website as well as on CDAR along with our MD&A and financial statements. I would also like to remind you that a replay of this call will be accessible until midnight on August 18th. Following management's presentations and remarks on the second quarter results, we will conduct a Q&A session for analysts only. Instructions will be provided at that time for you to join the queue for questions. Before we begin, we are required to provide the following statements regarding forward-looking information, which is made on behalf of Dolman Building Materials Group Limited and all of its representatives on this call. Remarks and answers to your questions today may contain forward-looking information about future events or the company's future performance. This information is subject to risks and uncertainties that may cause actual events or results to differ materially. Any information regarding forward-looking statements is made as of the date of this call and the company does not undertake to update any forward-looking statements. Please read the forward-looking statements and risk factors in the MD&A as these outline the material factors which could cause or would cause actual results to the firm. The company will not provide guidance regarding future earnings during today's call. Management does not anticipate providing guidance in future quarterly or interim communications with investors.

I'd like to turn the call over to Omar. Good morning, everyone. Thanks for joining us on today's call. On the back of a strong start to the year with our first quarter results, we're very pleased and encouraged with how the second quarter unfolded. During our last call, I highlighted that we continued to work through pricing volatility in a challenging year over year pricing comparatives. We like where it sits at present times. These trends continue to exist in our day-to-day activities. However, our focus remains on what we can control to ensure we maximize margins and free cash flow generation. Our teams focus on inventory management with the goal of optimizing gross margin performance combined with our constant efforts on overall cost management. We're key contributors to our success in a strong second quarter. Demand also remains steady across all key end markets during the quarter with volumes in various categories showing no sign of wavering. However, given the lower pricing for construction materials on a year-over-year basis, revenues were lower in the second quarter when compared to the same period last year as expected, but at much improved margins. To put this in numbers, gross margin for the second quarter was 17% compared to just under 12 a year ago. Our financial and operational performance in the second quarter is a testament to our ability to work through volatile markets and our team's track record on managing the business through similar cycles. Throughout the quarter, we remain laser-focused, as always, on our margins and optimizing our balance sheet. To put the decline in lumber pricing and commodity pricing in perspective, year-over-year lumber is down in price 51%, OSB is down 54%, plywood is down 39% in price. Our ongoing cost management focus on operational efficiencies and successful integration efforts enabled the company to realize strong gross margin and EBITDA margin performance, despite the massive deflation in commodity pricing. I am both pleased with and very proud of our financial performance, specifically from a pricing trend perspective, where we have had to be extremely responsive to industry-wide price volatility, while ensuring that our first-class level of service remains on point. As a result of our collected efforts, revenues amounted to $710 million, Gross margin remained strong at 17% or $121 million. EVA DA amounted to a strong $66 million. Net earnings came in just under $30 million. And we paid our 55th quarter in a row of dividends at $0.14 a share. Looking ahead, we are cautiously optimistic as we believe that the pricing environment and market demand is nearing equilibrium at healthy levels. While we continue to manage our costs and always look for growth opportunities. Our balance sheet optimization strategy is also tracking well with roughly 230 million of debt reduction since our transformative acquisition of Hickson Lumber two years ago. Debt reduction is a key priority for us as we look forward to having the solid, growth-friendly and fire-ready balance sheet for opportunistic acquisitions that we are always working on. As always, we remain confident in our ability to work through volatile markets diligently while serving our customers' needs at the highest level of service. We remain excited about our growth profile and our overall prospects of the business We have built a solid, diverse, and resilient business in North America with a broad and growing footprint, which we are extremely proud of. I want to thank our team across North America, our customers, and our suppliers for working so well with Dolman Building Materials for another strong quarter with all of our partners, and again, starting with our staff. With that, I'm going to hand the call over to Jay Cote, our CFO, who's going to take us through the numbers, and then we'll take some calls from analysts later on. Thanks very much, and Jay, over to you. Thank you, Amar, and good morning, everyone.

Sales for the quarter ended June 30, 2023, were $710.7 million, compared to $870.7 million in 22, representing a decrease of $160 million, or 18.4%. The decrease is largely due to the impact of lower construction materials. Pricing was generally declined since reaching a peak for last year in the month of March. The company's sales in the quarter were made up of 77% construction materials, consistent with Q2 last year, with the remaining balance resulting from specialty and allied products of 20% and other sources of 3%. Gross margin dollars increased to $121.2 million. in the quarter compared to $102.7 million last year, an increase of $18.5 million. Gross margin percentage was 17% in the quarter, an increase from the 11.8% we achieved in 2022. The relatively stable pricing environment during the current quarter resulted in higher percentage and dollar margins realized by the company contrasted with the negative impacts of the significant price volatility experienced in 2022. Expenses for the current quarter were $72.5 million compared to $67 million last year, an increase of $5.5 million, or 8.2%. And as a percentage of sales, expenses were 10.2% this quarter compared to 7.7% in 22. Distribution, selling, and administration expenses increased by $4.6 million, or 9.1%, to $55.2 million in Q2 from $50.6 million last year, largely due to recent broad inflationary pressures contributing to higher expense levels during the current quarter. As a percentage of sales, these expenses were 7.8% in the quarter compared to 5.8% in 22. Depreciation and amortization expenses increased by $925,000 or 5.7% from $16.4 million to $17.3 million, largely due to the impact of foreign exchange on translation of our U.S.-based operations. Finance costs this quarter were $10.5 million compared to $9.6 million in 22, an increase of $924,000, or 9.6%, largely due to this quarter's higher interest rates on our variable rate loan facilities, which was partially offset by lower average loan balances this year. This quarter's EBITDA was $66 million compared to $52.1 million last year, an increase of $13.9 million or 26.7%. The increase in EBITDA was primarily a result of the higher gross margins this quarter driven by the relatively stable construction materials pricing as contrasted with generally declining prices experienced during Q2-22. Doman's net earnings this quarter were $29.2 million versus $20.7 million in 2022. Turning now to the statement of cash flows, operating activities for the six-month period ended June 30th consumed $6.7 million compared to $9.9 million consumed in 2022. This period's relatively lower net earnings were offset by stronger working capital metrics driven by stringent inventory volume management and generally lower construction materials pricing. Operating activities before non-cash working capital changes generated $85.8 million in cash compared to $97.6 million in 2022, while seasonal changes in non-cash working capital consumed $92.5 million in cash compared to $107.6 million in in the first six months of 2022. Overall financing activities generated a net cash amount of $8.8 million from equity and debt stakeholders compared to $5 million for the comparative six-month period in 2022. Payment of lease liabilities, including interest, consumed $13.1 million of cash compared to $12.2 million in 2022. And the company's lease obligations generally require monthly installments, and these payments are 100% current. In this six-month period, we borrowed an additional $120.5 million on our revolving loan facility, compared to $43.2 million in 2022. We utilized excess availability under the revolving loan facility to redeem our $60 million 2023 unsecured notes and to repay the $14.1 million balance on our non-revolving term loan, both in the month of June 2023. Total net advances on loans and borrowings increased by $4.8 million year over year, largely a result of the previously discussed lower net earnings positively offset by strong working capital control, resulting in the slight increase in facility utilization this year. Shares issued net of transaction costs generated $609,000 of cash compared to $618,000 in 2022, The company also returned $24.3 million to shareholders through payment of dividends during the six-month period, which was consistent with payments made in the first half of 2022. We also note the company was not in breach of any of its lending covenants during the six-month period ended June 30, 2023. Finally, we invested $2.3 million in new property, plant, and equipment compared to net investments of $2.9 million last year. This concludes our formal commentary, and we would now be happy to respond to any questions that you may have. Thank you. Operator?

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Thank you. Our first question comes from Hamir Patel with CIBC Capital Markets. Please proceed with your question.

Good morning. Amar, are you able to give us a sense as to how your treated volumes are tracking year-to-date and any maybe differences you might be seeing between Canada and the U.S.?

Yeah, I think we could answer very confidently that our volumes in most markets are up from 2022. As you know, in the back half of last year, volumes did fall off quite a bit as well, but Having said that in the first half, we've exceeded last year's volumes in virtually all market segments that were involved.

Okay, great. Thanks. That's helpful. And Amar, with respect to margins, obviously a very strong quarter here in Q2. How do you think about where gross margins for the business could stabilize over the long term?

Yeah, it's a nice margin profile this quarter. Everything lined up well, and I would call it a normal lumber market. Things were ticking up a little bit, but we didn't get a ton of tailwinds with lumber running up or anything like that. So it was just a nice blocking and tackling quarter. It was good. I would say as we go forward, if the lumber market remains consistent, we'll be in that kind of a range. I would say that that was a very, very strong quarter where things aligned very well. So We're hoping it'll be in that range. I wouldn't say pushing too much higher than that. I think that's pretty strong for us, as you know. But things align well depending on where the lumber market goes. Great. Thanks.

That's all I had. I'll get back to you.

Thanks, Samir.

Thank you. Our next question comes from Paul Quinn with RBC Capital Markets. Please proceed with your question.

Yeah, thanks very much for the morning, guys. Just following up, just on overall business conditions, what are you hearing from your customers as their expectations for the second half of the year and into 2024? Are they relatively optimistic at this point?

You know, I don't think anybody's optimistic. It's a weird environment, Paul, and thanks for your question. I would say that everybody is still running hand-to-mouth on inventories. This thing is not where people are getting ahead of themselves. You know, it does appear like the new housing construction industry is in sort of a demand zone where there's so many mortgages that were done at low rates. There's just not a lot of inventory out there. And this is a demand-driven housing market on the rental side as well for multi. So we're seeing a lot of strength there, but no one's wildly optimistic by any means. The numbers are good. They're consistent. Everybody's scared to over-inventory just like they were kind of starting in the first quarter last year. It's the same hand-to-mouth. You need 10 trucks, you buy five. And that's why we get these flash rallies. In my view, everyone kind of bum-rushes at the same time when they're all out, and it creates a spark, and then it fades again. And I think we're in that trading range I talked about last quarter.

Right, okay. And then, you know, just it's curious to see, you know, most of the companies I cover, they sort of move with the commodity price. It seems like with stability, you guys, your gross margin seems to be, you know, seems to hit a sweet spot. Is something consistent through, you know, most of the time that you run the company?

Absolutely. And, you know, you take the COVID noise out of those wild swings that we all saw up and down, you know, when we've got a relatively normal lumber market or stable, you're going to see those gross margins very, very steady. And, you know, any comments on that, Jay?

Yeah, no, we've seen that, as Amar said, pre-COVID. If you go back a You know, it's a slightly different margin profile now that we've added. Hickson during COVID two years ago this month, and that certainly enhances the margin in a steady market. Hickson's, you know, performing well in this market, in the southern yellow pine category.

Okay, last question I had. Any business that you've done, any part of your business doesn't do well in this sort of steady environment?

You know, cedar's been a bit challenging inside, you know, one of our divisions a little bit, and our logging side has been really wet until recently. Now it's, you know, it's too dry, it seems, but those are very small parts of the business, so nothing material. It seems that, you know, having this decent lumber market, you know, gave us good legs here in the first and second quarter, and it's been evidenced into the third, so it's nice to see those consistent trends happen, but pretty much All facets of the company are running very well. All right. That's all I had. Thanks. Thank you.

Thank you. Our next question comes from Zachary Evershed with National Bank Financial. Please proceed with your question.

Good morning, everyone. Thanks for taking my question. Great quarter.

Thanks, Zach.

Can you tell us about the pricing of your existing inventory and at the local level what you're seeing in terms of pricing trends on lumber and panels?

Yeah, I mean, it's, you know, I think we got a little toppy, you know, a week ago and a couple of the species are looking like they've topped out. Don't see a collapse, but just it's kind of topped, good pricing. Our inventories are priced very well, as we might have indicated on our last calls, Zach. You know, we've really reduced our inventories company-wide, increased our turns, so we're much more live to the market for a lot of reasons. You know, obviously just, you know, concerned about an uncertain interest rate environment and all that kind of stuff, but we're running faster, leaner, better with less. Learned that through COVID when we couldn't get material and all that kind of stuff. So those strategies are keeping us more fit, closer to the market, and I think that was evidenced by our gross margin in the first two quarters of the year.

That's good color. Thanks. And then building on that running faster and leaner, are you still expecting the usual seasonal patterns in the back half of the year in terms of not only the pace of sales and margins, but also the working capital movements?

Yeah, that's correct, Zach. We would expect the normal seasonal pattern of reducing inventory and receivables levels going through Q3. So that usage of the revolving loan facility you'll see come down when we report Q3 as is the normal pattern.

That's great. And then zooming out a little bit, a question for you given the recent news flow on lumber duties between the U.S. and Canada. Last time we touched base on the topic with you, you weren't really in the habit of moving product across the border. So number one, is that still the case? And number two, is there any impact to local markets? You can see.

Yeah, our Lignum division does do a little bit of that exporting, of course, you know, involved in that, but you know, they factor all that into their margins, et cetera, and have for years. So they clearly understand how to run that business very well. But the larger part of the treated lumber business and our, you know, North American distribution business can, well, we do not export virtually anything across the line. We do sell, Post poles and agricultural posts off our own timberlands that we manufacture, treat, and we do ship some down to the U.S., but nothing that would have any softwood lumber duties except our lignum division.

Good call there. Thanks. Then just one last one, a little bit more speculative. When rates come down and people get a little bit more optimistic, where are the bottlenecks in your vertical that would be the slowest to ramp up Is it you, your suppliers, customer production capacity, the rails?

You know, I think everything's into a good groove. You know, I'm not sure we'll get a runaway here, but it seems that it's sort of a back and fill kind of economy. The supply chains have caught up. The mills have kind of caught up. And, you know, we've got decent pricing out there. It's not, you know, great pricing by any means. You can see the sawmills. A lot of them are in the red right now, unfortunately. But, you know, I think that will come around as some production maybe comes off the market perhaps. But really, I think most of the supply chains have caught up. I don't think there will be a bottleneck unless, you know, there's a housing, you know, boom again here. But with rates the way they are, you know, I think we're just going to be steady as she goes. Having said that, if there was a massive pickup, I think the bottlenecks, you know, certainly would be at the manufacturing level of lumber and then perhaps transportation in the rails.

Great answer. Thanks.

I'll turn it over.

Thank you. Our next question comes from Yuri Link with Canaccord Genuity. Please proceed with your question.

Good morning, Jay. Good morning, Amara. Good morning, Yuri. Nice quarter, guys. Just a quick one from me. Balance sheet's looking... pretty good shape here. Really nice deleveraging. Amar, how would you characterize the M&A outlook and just the expectations on behalf of potential sellers out there and how active you might be over the next year? Thanks.

Yeah, we're pretty active on that front always. And as you know, sometimes these things take a lot of time to build those relationships in order to get a transaction completed. The valuations On certain businesses are sort of coming back to earth as far as what expectations are. So we like to see that. There's a lot of geography for us to run yet in the U.S. that we're actively engaged with and we will be involved with. So, you know, when you look at the map, you can certainly see where we are and where we aren't. And we will be in those markets. Our customers would like us there. And us being national, you know, in the U.S. is a big priority for us and to our strong customer base there.

Okay, that's helpful, guys. Great quarter again. I'll turn it over. Thanks.

Thank you. Our next question comes from Ian Glills with Stiefel. Please proceed with your question.

Morning, everyone. Morning, Ian. With the Hickson anniversary coming up, I mean, you obviously bought that during a very dynamic time in the market. Have the gross margins for that business settled out in a bit of a better place than you would have anticipated even at the time of the deal?

Yeah, they have. And a couple of things, Ian, that's a great question. We've invested in technology, as we said we would do in that business. It's now our 25th month of operating with the great Hickson folks, and we've certainly come a long way quickly. They've executed well, not only joining a public company like ours, but the technology implementation went without a flaw, you know, in all of our 19 treating plants and the sawmills, and it's running very well. And that's allowing us to extract in mind the information that we thought we could and get more sophisticated on margin, freight recoveries, et cetera, like we do in all of our other divisions. We think very, very well. And Hickson's getting to that level quickly, and it's almost okay. Now we can really start to see how we can squeeze and get those gross margins up. And the southern yellow pine market giving us just a consistent platform really started to demonstrate the cash this business can throw when we're in a normal market. So long answer to your question, but our investments in that business and how well they've executed has really aligned nicely.

No, that's helpful. And I guess to put a finer point on that, if I historically have thought of this as like a 13, Doman is a 13 to 15% gross margin business. Given what you've just talked about with Hickson and the contribution, is thinking about it more like 14% to 16% range now a bit more appropriate?

Yeah, I think 14% is even light as far as a consistent basis with the weighting of Hickson in there in a normal lumber market. We always have to put an asterisk there because if lumber starts to drop, there's always some pain because some of our customer base is tied to random lengths weekly. So we ebb and flow with that depending on our inventory levels in-house and our contract wood with the mills. So there's a lot of that goes into the cauldron to make that margin happen. But if we don't have wild swings, those goalposts that you just mentioned are the zone for sure. And 17 being up towards best in class.

No, that's very helpful. I'll turn the call back over. Thanks again.

Thanks.

Thank you. There are no further questions at this time. I would now like to turn the floor back over to Ali for closing comments.

Thank you, operator. On behalf of the Dolan Building Materials Group Limited team, I would like to thank you for joining us this morning. We look forward to speaking with you again on our third quarter conference call. That concludes today's call. Have a great weekend, and I'll turn it back over to the operator.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.