Earnings Call: Q1 2019

Apr 4, 2019

Good afternoon, ladies and gentlemen, and welcome to Richelieu Hardware's first quarter 2019 results conference call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question and answer session, which will be restricted to analysts only. If at any time during this call you require immediate assistance, please press star zero for the operator. Note that this call is recorded on Thursday, April 4th, 2019. [Foreign language] Je vais maintenant céder la parole à Monsieur Richard Lord, président et chef de la direction. La parole est à vous. Merci. Good afternoon, ladies and gentlemen, and welcome to Richelieu's conference call for the first quarter ended February 28, 2019. With me is Antoine Auclair, CFO. As usual, note that some of today's issue include forward-looking information which is provided with the usual disclaimer, as reported in our financial filings. This year, we have made a very good start in terms of business acquisition. During the first quarter, we closed three new acquisitions in Canada: Lion Industries, Blackstone Building Products, and Truform Building Products. These three specialty hardware distributors serve a customer base of window and door manufacturers in Ontario and Western Canada from their three centers located in Calgary and Concord. They give us the opportunity to increase our business in the window and door manufacturers segment, reinforce our current presence in these markets, while adding CAD 12 million in sales. Now let's look at financial highlights. During the first quarter, our results were affected by lower sales to hardware retailers, including renovation superstores in Canada and in the U.S. First quarter sales reached CAD 226 million, up by 2%, of which 2.8% from acquisitions. Sales to manufacturers stood at CAD 192.3 million, up by 5.3%, 1.9% from internal growth and 3.4% from acquisitions. In the hardware retailers and renovation superstores market, sales stood at CAD 33.9 million, down by CAD 5.3 million or 13.5%. In Canada, sales amounted to CAD 123.7 million, stable with 2018. Our sales to manufacturers reached CAD 117.7 million, up by 4%. As for the hardware retailers and renovation superstores market, sales stood at CAD 26 million, down 15.9%. This is due to the fact that in the first quarter of 2018, our sales in Canada were exceptionally high in this market for a first quarter. In contrast, during our first quarter of 2019, our sales were impacted by the inventory realignment of our retailing customers in what seems to be a softer market. In addition, one of our major customers is in the process of closing some stores. So far, they have closed 25 stores. I would like to point out that we did not lose any market share or any listing with our hardware retailers customers. In the U.S., sales totaled $62 million, a slight increase compared with 2018. They reached CAD 82.5 million, an increase of 6%, and represented 36.5% of total sales. Sales to manufacturers reached $56.1 million, compared with $55.4 million, an increase of 1.3%, of which $7.4 million from acquisition and an internal decrease of 6.1% resulting from the end of a supply agreement with a major customer, as reported in previous quarters. Note that at comparable sales, internal growth in the U.S. manufacturer's market would have been 3%. In the hardware retailers and renovation superstore market, sales were down 9.2% in U.S. dollars. This decrease is due to the temporary effect of significant cyclical sales made to our major customers in the first quarter of 2018. Excluding this factor, the hardware sales growth in the U.S. would have been 50% due to additional market development. Given the cyclical nature of these sales, we are confident to recoup these sales in the coming quarters. First quarter EBITDA reached CAD 17.4 million, down CAD 2.4 million. Gross margin remained stable compared with the same period of last year. The EBITDA margin stood at 7.7% compared to 8.9%. It was affected by the slowdown in sales to the hardware retailers market during the quarter, the market development cost to increase our offering and our presence in the retailers market in the U.S., and tuning the additional costs incurred as a result of the temporary increase of our inventory and the effect of our recent acquisitions. Amortization expenses for the first quarter of 2019 was CAD 0.4 million, resulting from investment made in capital assets in 2018. First quarter net earnings attributable to shareholders totaled CAD 10.1 million, and diluted net earnings per share was CAD 0.18 compared with CAD 0.22 last year. First quarter cash flows from operating activities before net change in working capital balances amounted to CAD 13.9 million, or CAD 0.24 per share, a decrease of 13%. During the first three months, we paid dividends of CAD 3.6 million, up 4.4% over 2018. We also invested CAD 6.6 million, of which CAD 4.8 million for business acquisition and CAD 1.8 million to purchase new equipment in order to improve operational efficiency. As at February 28, 2019, bank drafts amounted to CAD 16.4 million, compared with cash of CAD 7.4 million as at November 30th, 2018. This change mainly arise from the increased inventory resulting from the following nine factors. The slowdown in sales to hardware retailers during the quarter, for which we usually keep more inventory in order to maintain close to a 100% service level. A normal increase in view of next periods that are historically the most active, and pursuing our continuous innovation strategy, adding new products in order to develop new business opportunities. The corporation posted a working capital of CAD 333.5 million for a current ratio of 4.2:1. To conclude, in the coming periods, we will continue to seize and create opportunities, building on our key strengths and strong financial position, implementing our innovation and market development strategies, and closing new strategic acquisition in North America. We are confident to produce positive results in the next quarter. That concludes my overview. Thank you for your interest, and now I'll be happy to answer your questions. Thank you. Ladies and gentlemen, if you do have any questions at this time, please press star followed by one on your touchtone phone. You will hear a three-tone prompt acknowledging your request. Note that questions will be taken in the order received. If you should wish to withdraw your request, please press star followed by two. We do ask that if you're using a speakerphone, to please lift the handset before pressing any keys. Your first question will be from Zachary Evershed at National Bank Financial. Please go ahead. Good afternoon. Good afternoon. A couple quick ones just off the bat. I was wondering if you could break down U.S. organic growth and acquisition growth in U.S. dollars. Yes, we have this information over here. U.S. internal growth is basically -6% from internal decrease. It's a decrease. Acquisition, it's 6.6% growth. Basically, the reason for the internal decrease is twofold. The cyclical sales on the retailers market and also the loss of the one customer that we've mentioning since the last four quarters. Excluding the effect of this one customer in the industrial side. The internal decrease is 6%, but excluding that effect, it's a growth of 3% on the industrial side. And on the retail side, excluding the impact of the cyclical sales for one customer, it's growth of 50% instead of a decrease of 9%. That's great. Thank you. Another quick one. Will CapEx in 2019 be consistent with the levels we saw in 2018 and 2017? You should see a bit of reduction because in 2017 and 2018, remember that we've invested a lot of money for our AutoStore system here in Saint-Laurent. The maintenance CapEx should be around the CAD 10 million mark. Thank you. Next one, going more in-depth on your gross margins and operating margins. We talked about market development cost to increase the presence in the U.S., temporary increases in inventory. Going forward, do you see pressures on the business or any kind of structural or cyclical shift that will result in lower margins? In essence, do you view RCH as a 10% EBITDA margin business? What we see is that our margins will be back to normal considering the decrease in the sales to hardware retailers. Actually, that does affect the bottom line directly because we have to keep up with the same expenses. Plus the fact that as a result of those customers that are not buying, our inventory has to be full 100% all the time because we're expecting those sales. Most of the product that we sell to that market segment comes from Asia, we could not stop the container. That does increase the inventory, resulting also in further expenses because our warehouses are full, we have to go for outside warehousing and a few other things like that. That costs some CAD. Did I forget something, Antoine? Basically, things should be back to normal as soon as the sales are back to normal. If end markets don't pick up and we see a bit of a structural slowdown, will you continue to have the drag from higher inventories? How long does it take to turn down that tap? Yeah. Actually, we try to close the tap right now if it's possible, and we will eventually if the sales are not back. I would be surprised if the market come back to a normal level with the hardware retailers. Usually this market is pretty stable. The do-it-yourself market has been always strong in Canada and should continue to be strong this year. I cannot explain the reason why, the point of sales for them seems to be lower than last year. Is it a matter of season? Is it a matter of something else? We don't know. Basically, usually this market is rather stable. It should be back. Regarding the cyclical sales, we already have the order in hand to confirm that we will sell at least as much as we did sell last year. We don't see any problem there too. That should be fine if the sales improve. If not, as you mentioned, there's no doubt we're going to close the tap. Understood. Last year, we were looking at somewhere around a CAD 40 million run rate per quarter for sales to retailers. In the last two quarters, it's been closer to CAD 34 million with the impacts that we've described. How good is your visibility on the next quarter? Which way do you think it'll lean, to the CAD 34 million or the CAD 40 million? It's hard to answer to that. I think the CAD 40 million seems to be a reasonable number. Yeah. Yeah, the first quarter, Zach, is always the weakest quarter as well. The spring season is always a busier season for the retailers. Hopefully this will come back to a more normal level. That's very helpful. Thank you. Just one last one for me. If we could get additional color on your end markets and the geographic performance in Canada. Yeah, the geographic is interesting. The industrial sales in Canada East is up by 4.6%. Western Canada is up by 3.6%, Ontario is up by 1.3%. Ontario seems to be weakening a little bit for the time being. On your various end markets, kitchen cabinets, that kind of thing. Yeah, kitchen cabinet are up by over 2.5%. We have the residential and office furniture market, which is up by 10%. We have other market, that I will explain the other market, which is up also by 10%. What we call other market, actually, we should maybe classify our information a little bit better. That consists of the window and door manufacturers, the glass customers, and the other distributor that we sell to. The three new acquisitions will be falling under the other category. The window and door. Beautiful. I'll turn it over. Thank you. Okay. Thank you. Next question will be from John Novak at CIBC. Please go ahead. My question was answered on the last one. Thank you. Good. Thank you. Next question will be from Robert Currie at Louisbourg Investments. Please go ahead. Hi, can you guys hear me? Hi. Perfect. Just a couple of questions on margins here. I've kind of been expecting margins to start to tick a little bit better. Seems like it's moving in the opposite direction. Can you guys just give me clarity on when, you guys have talked about before, I think, 11%-11.5% kind of normalized margins. Are you still expecting that? You just mentioned before that you are expecting things to normalize, can you just give me some color on how that's going to happen and the operating leverage in the business? What's important to understand is what's going to be happening with the retailer market. That's one thing. The other thing that impacts our margin in percentage is basically our acquisition. We've made some good acquisition last year where we're continuing to invest in acquisition. Of course, for some acquisition, mainly in the U.S., the level of EBITDA is not at the same level as the one that we have with Richelieu. We're going to be working and improving those acquisition. The value is there. The long-term value, that's really what we are looking at. Depending of the streak of acquisition that we're going to be completing, that could have an impact on our margin percent. Our basic business, industrial, either in the U.S. and in Canada, is in good shape, and the margin are stable or improving. If I could add something to that. Actually, we spend more for dollar of sales in the U.S. because we are trying to capture more and more market share. The other side, we invest more in new products. Our inventory increase consists of something like CAD 20 million on new product. Yes. It's like making an acquisition. Sometimes, investing in new products, you increase your inventory, you might temporarily increase your expenses, the goal is to sell more in the future. I think it's good money invested. It's like making an acquisition. Same thing for the investment that we do in the U.S. We could cut our expenses in the U.S. and have temporary, I would say, short-term and EBITDA much closer to what we do in Canada. I think for the long term, we have to keep on investing both in the sales reps that cover architects and designers, and so on and so forth, as well as developing the retailer market. It costs some money to develop some market. Personally, I compare that as making an acquisition. You invest money in order to improve your income in the future. I think this is exactly what we do. We think about the long term of this company and make sure that we will achieve the growth that we hope to achieve in the future. Yeah, that's helpful for sure. I guess I'm thinking as well, just on, you guys have talked about before about the kind of investment you made, obviously in the warehousing, but how that's also impacted costs. My understanding is that you're either lapping those costs now or you will be very soon. Can you just give me quick color on how that's going to shape up? Actually, regarding the investment that we made in the warehouse, actually really brought the benefit that we were looking for. If you look at the, it's been muted like I said the last meeting by transferring those expenses somewhere else like the changes that we've made into our warehouse in order to organize the area for the AutoStore created turbulence now that we have to re-adjust in the rest of the warehouse. Plus the fact that the retailers are not purchasing. We have new products coming in for CAD 20 million. Really that did create expenses, including outside warehousing and more employees in order to cope with that. Right. Yes, can you give me some color? One of the things, you guys don't give adjusted numbers, but if you could just give some color towards what would normalized EBITDA have been this quarter. I don't know if you guys are comfortable with kind of sharing if there are some puts and takes and what you guys see on more of a run rate basis, but that would be helpful, I think, too. What we could tell you is that the margins on the industrial market for our basic business are stable in Canada. They are slightly increasing in the U.S., so we're improving in the U.S. because sales are increasing. At the EBITDA level, we're gaining EBITDA percentage, that's for sure. What hurts us in the retail market, it's the volume, like Richel said. We lose the sales, but we don't have many operational costs in there. I would say that excluding this major variance in top line, the retail margin, and excluding also the investment that we're making in the network in the U.S., the margin are not reducing materially, that's for sure. It's an investment, so it impacts the bottom line. Important to mention, our gross margin was slightly higher in the manufacturer's market in Canada in the last quarter as well as in the U.S. Yeah, that's helpful. You guys are mentioning things like, for example, you're using external warehousing and stuff like that. You're starting to be at capacity. You're obviously alluding to that being a higher cost pressure on you guys. Is that something that's going to alleviate in the near future? Is that kind of a tail end? Sure. Yeah. When do you see that? Is that just waiting for those retailers to purchase that inventory that you guys have already bought? It's part of the retailer volume, but also it's moving those new products that we're investing in. That has an impact. Of course, the inventory situation is adding cost to our cost structure. Once this is behind us, the operational cost should be back to a more normal level. Yeah. That's helpful. If you can help me understand too, this is probably one of my last questions here, but trying to understand the comment you guys made on adjusting for the more cyclical purchasing in the U.S. retail, that you would've been growing internal growth of about 50%. Just seems like a dramatic change from what the number presented. Can you just help me understand the mix there of how that works and what you're really talking about? What's the mix of cyclical versus non and kind of how I can think about the U.S. business in that way? Yeah. Apart from the cyclical sales, actually, for the regular sales to the retailing customers in the U.S., we are developing new products with new customers. We have new products at Lowe's, for example, that we're installing. We're loading their stores, actually, and we have, what's the name? The True Value with which we increase our sales because we penetrate the market, one True Value member, one by one. Basically, that does create additional sales, but with not the margin that we're looking for because we have to incur the cost of getting into their stores, installing all this display, as usual. It's business as usual for Richelieu. It creates nice sales, but it's also a match with more expenses in order to get our products in their stores. We are very happy with that because for the midterm, it's a fantastic business that we're developing there. If I can add one thing. The cyclical sales, what's important to understand, it is with one customer. We can call it cyclical or seasonal, but basically one quarter you can receive a large PO for all of their stores. Next quarter, it won't be there. What we are expecting is that we had lower sales in this current quarter, but sales should come in the next two quarters because we- Right. That needs to buy from you. They are going to need to replenish inventory. It wasn't this quarter, but it could be next quarter or the quarter after that. Is that what you mean by that? We already have the order on hand to confirm we will sell at least the amount that we sold last year. Okay. The whole year. Thank you for that comment. Yeah, that's what I was going to get clarity on that too. Yeah, that's helpful. You're seeing quite an investment in working capital this quarter, as you've mentioned as well. Yeah. We're seeing for the first time, you guys. Well, I don't know if I should say it's the first time. It's not the first time. No. Well, I was going to say the first time for really being net debt, I guess you could say now with the bank draft. Yeah. What's kind of your capacity you guys are willing to lever up to? Let's say, for example, inventory still needs investment, but you see continued acquisitions or your stock price falls another CAD 2, CAD 3. Would you consider reinitiating the NCIB and start buying back more stock? Just want to get a sense for capital allocation as well. Yeah. We're always on the search for the NCIB, but the priority is acquisition. We have a lot of leverage on the balance sheet. It's definitely not an issue. Either we invest in acquisition, we invest in working cap. What you need to understand is priority is acquisition after we have dividend policy and also the share buyback that is in place. We could leverage a company three times the EBITDA, but we will do that for only for the right reason. For the right acquisition, we'll do it. We need to look at sustainable EBITDA. That's very important. We have a lot of rigor in our acquisition process, but we're not against leverage. It's that we didn't find the right opportunity to do it. That's helpful. I'm assuming the right opportunity, you're likely more looking south of the border. I'm sure you look at everything, but that's kind of where you'd rather it. Is that an accurate understanding? We're looking everywhere. We just didn't find it yet. Okay. Okay. Yeah. I'll turn it over. Thanks. Thank you. Thank you. Ladies and gentlemen, as a reminder, if you do have any questions, please press star followed by one on your touch-tone phone. The next question is a follow-up from Zachary Evershed. Please go ahead. Yeah. We've seen a little bit of activity initiatives from superstores in the space targeting the pro market, as well as some automated pickup lockers. Have you seen any impact on your market share in the U.S. or in Canada as a result of this? Have you noticed any change in the competitive dynamic? We have not seen such thing yet. What they do usually, they go after the pro market, but they don't have all the product. They could not service, for example, the cabinet industry, except for a few hinges and a few basic drawer slides. Most of the time, they buy products from our customers, which they resell to the consumers, and they supply the installation. This is what we see more and more. The other pro business that we see that they're doing, usually it's not affecting us for the type of product that we sell. We have to keep an eye on that, we never know. That's helpful. Thank you very much. Thank you. Thank you. At this time, Monsieur Lord, we have no other questions. I would like to turn the call back over to you, sir. Thank you very much. It's always a pleasure to talk to you. Have a nice day. Thank you, sir. Ladies and gentlemen, this does conclude your conference call for today. Once again, thank you for attending. At this time, we do ask that you please disconnect your lines. Enjoy the rest of your day.