Richelieu Hardware Ltd.

Richard Lord - CEO Antoine Auclair - CFO

Leon Aghazarian - National Bank Financial

Thank you. Good afternoon, ladies and gentlemen.

And welcome to Richelieu’s conference call for the second quarter ended May 31, 2018. 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. We have maintained good growth during our second quarter and first half ended May 31st, as we actively pursued our market development strategy and increased the synergies with our latest acquisitions.

We are pleased with our sales growth in Canada, where we did very well in our key market segments. In the US, our sustained market development efforts plus the contribution of our acquisition continued to pay off.

Our market share gain during the quarter, as such, minimized the impact of the termination of supply agreement with a major US customer. Thus, we were able to realize an appreciable US sales growth for the quarter and for the first six month.

We ended the period with good financial results and a good and strong financial position in order to pursue our growth strategy. Let’s look at our financial highlights.

Second quarter sales reached $263.4 million, up by 8.3%, of which, 4% from internal growth and 4.3% from acquisitions. At comparable US exchange rate to the same quarter of last year, sales growth would have been 9.9%.

Sales to manufacturers stood at $222.2 million up by 7%, 2% from internal growth and 5% from acquisitions. In the hardware retailers and renovation superstores market, we achieved sales of $41.2 million, up by 15.7%.

This growth resulted primarily from cyclical sales and the addition of new customers, mainly in the US. In Canada, sales amounted to $180.2 million, up by 10%, of which, 5.9% from internal growth and 4.1% from acquisitions.

Our sales to manufacturers reached $147.2 million, up by 11.7%. As for the hardware retailers and renovation superstores market, sales stood at $33 million, up by 3.1%.

In the US, sales totaled 64.7 million in US dollar, up by 9.7%. 4.4% from internal growth and 5.3% from acquisitions.

They reached 83.1 million in Canadian dollars, an increase of 5% and it represented 31.6% of our total sales. Sales to manufacturers reached 58 million in US dollars, up by 3.6%, of which, 5.5% from acquisitions and due to the termination of supply agreement with a major supplier, a decrease of 1.9% of internal growth.

With comparable sales, internal growth in the manufacturer market would have been 6.8%. Sales in US dollar to hardware retailers and renovation superstores were up by 137% from the corresponding quarter of 2017.

For the first half of 2018, sales totaled $485.3 million, up by 10.5%, 5% from internal growth and 5.5% from acquisitions. At comparable exchange rate to the first half of 2017, sales growth would have been 12.3%.

Sales to manufacturers reached $405.5 million, up by 8.9%. 2.3% from internal growth and 6.6% from acquisition.

Sales to hardware retailers and renovation superstores grew by 19.6% or $13.1 million to total $79.8 million due to our market development efforts that have resulted in significant cyclical sales in the first and second quarter compared to the same period last year, mainly in the US. In Canada, sales reached $324.3 million, up by $34.8 million or 12%, of which, 5.8% from internal growth and 6.2% from acquisitions.

Our sales to manufacturers amounted to $261 million, up by 13.3%, of which, 5.5% from internal growth and 7.8% from acquisitions. Sales to hardware retailers and renovation superstores grew by 7%.

In the US, sales amounted to 126.7 million in US dollar, up by 13%, 8.2% from internal growth and 4.8% from acquisitions. They reached 161.1 million in Canadian dollar, up by 7.6%, accounting for 33.2% of total sales.

Sales to manufacturers reached 113.7 million in US dollar, an increase of 6.7%, of which, 1.7% came from internal growth and 5% from acquisitions. Sales in the hardware retailers and renovation superstores market were up by 132.1% in US dollar.

Second quarter EBITDA reached $28.1 million, up by $1.4 million or 5.4% over the second quarter of 2017. Gross margin was down from the second quarter of 2017, influenced by the lower gross margin of our recent acquisitions due to their different product mix as well as to direct sales initiatives in the retail market with lower gross margin.

As a result of increased market development costs, the consolidation of two of our distribution centers in Western Canada, the reorganization of certain distribution centers and the cost of implementing new technology, the EBITDA margin stood at 10.7% compared to 11% last year. First half EBITDA was $47.9 million, up by $2.9 million or 6.4%, and EBITDA margin stood at 9.9%.

Second quarter net earnings attributable to shareholders totaled $18.2 million, up by 3.3%. Net earnings per share were $0.31 basic and diluted, an increase of 3.3%.

Amortization expenses for the first half of 2018 amounted to $6.5 million compared with $5.4 million for the same period of 2017, up by $1.1 million, resulting mainly from the increase in capital and intangible asset acquired last year. First half net earnings attributable to shareholders reached $30.9 million, up by 4.4%.

Net earnings per share was $0.53 diluted, up by 6%. Second quarter cash flow from operating activities before net change in working capital balances amounted to $22.4 million or $0.38 per share, an increase of 7%.

For the first half, they were up 7.5% totaling $38.5 million or $0.66 per share. For the second quarter of 2018, dividends paid to shareholders amounted to $3.5 million, up by $0.2 million over the corresponding quarter of 2017.

During the first six months, we paid dividends of $6.9 million, up by 5.4%, and repurchased common share for $5.2 million. We also invested $6.6 million, of which, $2 million for business acquisition and $4.6 million primarily for the purchase of equipment to improve operational efficiency.

As of May 31, 2018, net cash totaled $9.4 million and our working capital was $321.5 million for a current ratio of 4.8 to 1. Turning to our outlook.

For the second half, our priorities will remain to focus on our innovation and our market penetration and development strategies; to build further synergies with our latest acquisition; to further improve operational efficiency; to identify and select acquisitions targets in North America, which are fully compatible with our long-term growth objective; to continue to optimize our new auto store technology in Saint-Laurent that will contribute to further strengthen our competitive advantage in our market. We continue to invest in our web technology in order to maintain our leading position and increase our B2B sales.

Together with our excellent team, we will continue to build on our market knowledge and customers and innovation-oriented business model to record healthy result in the coming quarters. That concludes my overview.

Thank you for your interest. We would now be happy to answer your questions.

My first question just on the termination of your supply agreement. Can you just disclose a little bit more color there, I mean what were the reasons behind that and we’re calculating about a $5 million revenue drag there.

Would that be correct and is that kind of how to look at it going forward as well?

You are absolutely correct. Basically we continue to deal with that customer, but for certain products that we were supplying them, this customer decided to buy directly from Asia, because they have restructured their purchasing department and they have decided to go differently.

But we -- they remain a good customer, and we continue to do business with them, and that will go on for the rest of the year and that will -- quarter-after-quarter, you’re going to see those missing sales for the rest of the year at least.

Okay. So I guess, because -- the second question here would be, I mean there’s a lot of uncertainty surrounding, I mean US trade discussions with Europe and China.

I mean so that’s not related to that, right? Because we’d like to get more color about the positive -- about the possible negative impact on US tariffs, right?

I mean I think 75% of Richelieu’s purchases are made from foreign manufacturers. So just trying to get some sense of what potential impact there could be and in terms of inflationary costs for you?

Okay. Regarding that -- those -- let’s say, that loss with that customer, that has nothing to do with the new tariff.

But regarding the new tariff, what we’re going to have to do, I would say, in the next couple of weeks is to increase our price in the US and in Canada as well for other products. So we’re going to have to live with whatever is decided by the US Government.

But fortunately, all the supplier -- customers and -- are aware of that as well as our competitor as well. So that will be a trend in the market that will certainly create inflation for a while.

And so what percentage of your purchases will be exposed to that, you would say?

We have approximately 20% in China and 15% to 20% in Europe. The rest is mostly in North America.

Okay. So the exposure there would be on the 20% on the Chinese side and the 15% on the European side, right?

Yes, that’s it.

Possibly.

Possibly, and then that would be on some of the products or on most of the products that you’re getting in or what’s the view there?

Some of the products.

Okay. If we can move on maybe a little bit, just maybe comment on the performance of the end markets in terms of maybe the kitchen cabinetry and the commercial renovation setup, which segments showed better growth than others I would say?

Yes. In Canada actually before acquisition, kitchen cabinet manufacturers sales in the last quarter increased by 6.6%.

The commercial millwork increased by 6.5%. And we had residential and office furniture that increased by about 18%.

And we have other market that increased something like 5%.

Okay. And then within what geography would that be specifically within Canada.

Was there a more strength in Eastern Canada, Ontario or the West?

Just for the manufacturers, sales in Eastern Canada increased by 7%, in Ontario by 4%, Western Canada 8%.

Okay. That seems to be quite strong all around.

I mean we realized -- maybe on the margin side, I mean we realized there were some initiatives that were taken since the beginning of the year. We saw the effect of that in Q1 as well and now in Q2, particularly as it pertains to some of the new technologies you’re implementing as well as some of the reorganization of some of your distribution centers.

Just kind of looking forward, I mean do you still expect to see that impact in Q3 and Q4 into ‘19 or kind of how should we look at the margin profile from a year-over-year perspective for the balance of the year?

I think in the fourth quarter, we’re going to see -- we’re going to be finished with those reorganization. But we’re very proud about our investment here in Montréal for the warehouse with those auto stores’ technology, that will really put ourselves into very competitive advantage compared to our competitors because I don’t think that anybody in Canada has the -- any of our competitors in Canada has the ability to invest in such a system because of the volume that is required to justify those investment.

So it’s a big plus. Regarding the reorganization of New Jersey and Western Canada, well, that has to be done.

It’s a growth situation where we have to expand our space and we need to be better organized, and that’s part of the growth. That’s something that we -- it was a must to do for us and we’re almost finished with that now.

So would you still expect any more of the reorganization of distribution centers or will there be more cost associated to that or?

That would be finished in the third quarter. As of the fourth quarter, everything should be back to normal.

And at what point do you expect to see some of the benefits of that? I’m just looking for kind of a look into the margin profile for the latter half of the year.

I guess we’re going to see -- we’re going to start seeing the benefits in the fourth quarter. And we’re going to see also the benefit in 2019 as well, for the whole year is my point of view.

Okay. And then last question from me would be just on the retailer side.

I mean on the Q1 call, you mentioned price increases for retailers that took place on April 1st. Can you talk to us a little bit about that and how that’s been -- I mean how much of the growth has been that we’re seeing associated to the price increases versus maybe volume and maybe some color there please?

Well, in Canada, we are very strong. For the first two quarters, our strong hardware retailer -- it was very strong because before price increase, a lot of people placed their orders before the effect of the price increase.

So that has created some additional expenses -- additional revenues for us and plus the fact that we have new customers and that if you compare with the year before, we had new customers that joined the party. So basically what we -- up to now, probably the normal growth will continue on between 3% and 5%, that reported for a couple of quarters consist of the about a 3% price increase plus growth of about 2%, that’s my feeling in Canada.

In the US, I think we’re going to have a good growth in the quarters to come because of new customers that we’re working on, actually we’re establishing ourselves in new stores, I guess in the -- maybe -- not necessarily for the next quarter, but for the quarters to come, we should benefit from increased sales.

And sorry, and just a circle back very quickly on the price increases to mitigate the US tariffs, when do you expect those to be in place?

That would be in place as soon as -- we have to pay those tariffs, and I would say, some price increases could take place next week and some orders in two weeks from now. Basically, we’re going to try to be a little -- slightly in advance to the cost increase with our price increase.

Congratulations on a strong growth this quarter. I have two questions.

I noticed that gross margins have been declining for some time now, and there’s obviously some one-offs such as investment technology, consolidation of warehousing operations. But there was a bit also on lower gross margin from direct sales to retailers and product mix.

I’m just curious, is that a trend that we can expect to continue or do we expect to see a bit of uptick in gross margin from those efforts?

I don’t know if we could explain it that way, but if we would speak about only the same-store sales meaning that the same sale that we had two years ago, when we didn’t add those sales to -- direct sales to certain customers and to other type of customers that require lower margin, I think the margin will be exactly the same that they were for the last five years at least. So -- but actually, we are aggressively pursuing additional sales, and we’re looking at the bottom-line basically.

So we have sometimes to sacrifice for new sales, additional sales, some margin. But at the bottom line, these sales are very good contributors as well.

And also, the new acquisition, the company that we acquire usually did not have the product mix that we have. So they contribute to lower gross margin, plus the fact that in the US, the mix is not exactly the same as well.

The more we serve in the US, the more we sacrifice from point of our global margin, but the purpose is to improve the product mix in the US as well over the years in order to catch up in Canada.

Okay, perfect. My second question is regarding share buyback.

You mentioned that I think $5.2 million was bought back this past year which is an increase over last year. Can we -- is there an expectation that, that increase will continue and will there be further buyback in the coming year?

Yes. We’re going to -- we are always on the market and if there are blocks available, we’re there.

So we feel that it’s -- at this price, it’s a good investment. So we’re going to be there always on the hunt for blocks.

Okay. If there is no more questions, I would like just like to thank you all of you.

And you can call us if you need more information at your convenience. Thank you very much.

And have a nice day.