Beacon Roofing Supply, Inc.
Q2 2013 Earnings Call Transcript

Published: 10 May 2013

[Operator:]

Good morning, ladies and gentlemen, and welcome to today's Beacon Roofing Supply's Fiscal Year 2013 Second Quarter Conference. My name is Sarah, and I will be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. This call will contain forward-looking statements that fall within the Safe Harbor provisions of the Private Securities Litigations Act of 1995 regarding future events and the future financial performance of the company, including the company's financial outlook. Bear in mind that such statements are only predictions, and actual results may differ materially as a result of risks and uncertainties that pertain to our business. These risks are highlighted in our quarterly and annual SEC filings. The forward-looking statements contained in this call are based on information as of May 10, 2013, and except as required by law, the company undertakes no obligation to update or revise any of these forward-looking statements. Finally, this call will contain references to certain non-GAAP measures. The reconciliation of these non-GAAP measures is set forth in today's press release. On this call, Beacon Roofing Supply may make forward-looking statements, including statements about its plans and objectives and future economic performance. Forward-looking statements are subject to a number of risks and uncertainties. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including, but not limited to, those set forth in the Risk Factors section of the company's latest Form 10-K. The company has posted a summary of financial slide presentation on the Investors section of its website under events and presentations that will be referenced during management review of the financial results. On the call today for Beacon Roofing Supply will be, Mr. Paul Isabella, President and CEO; and Mr. Joe Nowicki, Executive Vice President and Chief Financial Officer. I would now like to turn the call over to Mr. Paul Isabella, President and CEO. Please proceed, Mr. Isabella.

[Paul M. Isabella:]

Thank you. Good morning, and welcome to our second quarter earnings call. We delivered breakeven or minus $0.02 adjusted EPS in the quarter versus $0.07 in Q2 of last year. We do recognize we had a very challenging quarter due to strong sales growth comparisons from Q2 of last year and harsh wet weather in most regions, weather that continued into parts of April and May in the Midwest in particular. In terms of EPS, I believe it's important to note that since going public only in 2005, '06 and '12 that we delivered positive EPS in the second quarter. Q2 has always been our weakest quarter due to winter weather. Our sales for the quarter were a record $416 million, which is approximately 5% above last year, and we were able to increase our gross margins by 20 basis points year-over-year. Our slight negative organic growth is somewhat encouraging given the prior-year comparisons and weather as I have mentioned. As a reminder, last year in Q2, we had total sales growth of 33% and organic growth of 28%. Organic residential growth last year was 46% and Commercial was 17%. So when I match up our 2013 Q2 numbers against last year, last year's results, I have a positive view of what our team delivered. And as we track our results internally, we delivered EPS close to our plan. As I have said on past calls, we recognize that quarterly fluctuations in sales and EPS occurred due to a number of factors, including demand and weather variations in our markets. As in the past, we will continue to focus on the long-term market fundamentals, and of course day-to-day execution of our operating plan. In the quarter, overall selling prices were flat to last year, and we were able to deliver higher gross margins as mentioned. We believe pricing in the quarter was impacted by lower demand for both Residential and Commercial products. Gross margins will continue to be influenced by a number of factors such as mix, market demand and of course product cost. We're pleased with the Q2 gross margin results. Our acquired markets generated $41 million of sales for the quarter and are making good progress with regard to the integration process. The results are expected to improve as we move through the year. Our acquisition pipeline is still very full, and we continue to talk to attractive companies. We are also placing more emphasis on our greenfield branch openings, and plan on opening roughly 10 new branches this year as I mentioned on the Q1 call. We will continue this effort moving forward as we plan to open 10 to 15 new branches per year. And now as I've done in the past I'll give a little more color on sales pricing and EPS. With regard to sales, by month, Q2 organic sales were as follows

[Joseph M. Nowicki:]

Thanks, Paul, and good morning to everyone on the call. I'll highlight some of the key financial results and metrics contained in our earnings press release, Form 10-Q filing and the second quarter slides posted to our website this morning. Total sales for the quarter, aided by our acquisitions, increased 5.3% to second quarter record of $416 million. Our fiscal 2013 second quarter organic sales decreased 5.1%, and this represents our existing markets and excludes sales of branches acquired since the beginning of last year's second quarter. It's important to note that we are up against a 28% organic sales increase in last year's second quarter when we had unusually warm weather. Our sales in existing markets by product group declined as follows

[Operator:]

[Operator Instructions] We'll go first to Michael Rehaut of JPMorgan.

[Jason Aaron Marcus:]

This is actually Jason Marcus in for Mike. So my first question is on gross margins. So far this year, you've seen a nice improvement, and just looking into the end of the back half of 2013, do you think that it will be fair to assume that gross margins can continue to improve on a year-over-year basis for the next 2 quarters?

[Paul M. Isabella:]

I think what you'll see, we have said it even last year earlier, before the year began, and we've been able to telegraph, I think quite well, that gross margins would be in that low 24% range. I think as we look out to the back half, we see -- we do see some increase, but we're in the small basis points, 10, maybe 20 as we go through the back half and through a more robust selling season.

[Jason Aaron Marcus:]

Okay. And then next, on the SG&A. So the SG&A came in a little bit higher than we were looking for, and I think that was really driven by the higher SG&A from the acquired market, the 35.9%. And so, I guess, the first part is how long does it typically take to bring down acquired market SG&A to the company average? And then are you still comfortable with SG&A for the full year kind of in the 17% to 18% range?

[Paul M. Isabella:]

Yes, we are comfortable in the 17% to 18% range, and there's no doubt that -- and it also, some of it depends on the mix of the acquired markets. If it's heavy residential and roof load, it may have a little higher SG&A. But typically there, we're looking -- as purchase accounting leads down to normalize it within the first 3 years, it gets down closer to the 19% range. I think an ongoing base would be in the more 17% to 18% or a little higher than 18% for the acquired markets. So yes, there's a combination of the acquired -- the start up costs purchase accounting in the quarter, no doubt. And then also just the overall impact of the sales being off a bit that put pressure on the cost piece because we certainly aren't going to rip so much costs out that it hurts the business.

[Operator:]

Our next from KeyBanc Capital Markets, we'll hear from Ken Zener.

[Kenneth R. Zener:]

Can you talk about the -- I guess, I understand your comments on the gross margin, but could you just update us perhaps on the spread between res and non-res?

[Paul M. Isabella:]

Yes, I think it's really hasn't changed for us much. We've been talking over the last, what, 12 months, Ken, probably that it's in the 1,100 to 1,200 basis points and it feels like it went up a couple of years ago, where we have, I think, partly I said 900 to 10 points roughly. And now we're up. That hasn't changed.

[Kenneth R. Zener:]

Okay, and, I guess, as we think about the acquisitions coming in, that's basically a 400 basis point lower mix, right? As those are kind of moving through the first 12 months of the year?

[Paul M. Isabella:]

In terms of gross margin?

[Kenneth R. Zener:]

In terms of overall margins.

[Paul M. Isabella:]

I can't -- is it gross, are you talking gross margins or [indiscernible] ...

[Kenneth R. Zener:]

No, that would be EBIT.

[Paul M. Isabella:]

Yes, I mean, they're naturally going to be lower as they come in because of the burden of start-up costs and purchase accounting. So yes, we -- as we talk about where we think they're going to be for the year, it's in that mid-single digit operating range to finish the year out. So yes, they're naturally going to be -- they always are lower in that first year. And then as we burn off that, improve operations, integrate them as we do, then it moves up to the company average.

[Kenneth R. Zener:]

And would you say your comments around industry-wide price increase that you had in your press release given what we had happen last year, can you -- what is your sense of the channel? I mean, there was a -- obviously, a large competitor had disclosed some information. But what is your sense of where the industry is and the likelihood of this February, which is now hitting in April, May, sticking and then the next one actually holding, if you would?

[Paul M. Isabella:]

Sure, yes, I think a couple of points

[Kenneth R. Zener:]

The second one?

[Paul M. Isabella:]

I don't know so much about the second. That was going to maybe take a little longer. I think I'm really referring to the first that just started to get through the market now. The second one, we're just going to have wait probably another 2 months, probably gated, Ken, by volume, too.

[Operator:]

William Blair's Ryan Merkel has our next question.

[Ryan Merkel:]

So I wanted to go back to an earlier question on gross margin just so I heard you right. Did you say that gross margins in the third and fourth quarter could be up year-over-year by 10 basis points?

[Paul M. Isabella:]

No, this is more of the sequential -- I'd have to look at what we did last year in the quarter, but more sequential of where we're at now, just slightly up as we go through the balance of the back half. If you look at last year, we're in the 25% range. So they're going to be lower than last year. It's more due to year to date.

[Ryan Merkel:]

Got you, so it was a sequential comment. Okay. And then I wanted to ask about, what do you think acquisitions will add to EPS in the back half of this year?

[Paul M. Isabella:]

Well, we have talked, I think, on the last call that we thought it'd be accretive by $0.10 or so. And given the -- and really, was part of our plan to have lower sales in the first half just because of the way they came in when they're acquired in the winter. I think we'll probably see in that $0.08 range, something like that for the $0.06 to $0.08 range for the back half.

[Ryan Merkel:]

Okay. And then I want to ask about the non-resi market. I know weather's impacted things there, but is that the primary driver? Or is there more to it than that? Is demand just weaker? I think the government sequester has got to have some impact there.

[Paul M. Isabella:]

That's a great question, Ryan. All indicators and all data points I'm able to pull from say that it isn't necessarily a weak demand situation because of the outlook or the economic indicators. I mean, there is no doubt and you can go through the Carlisle transcript, right of what they saw, and they've been actually doing quite well in recent quarters. They were pushed down big time by weather. I think as we talked last fall, there was a natural fall off in public work, and then it just continued with the more difficult weather conditions. I don't see, though, any underlying issue with demand, like we're just going to have a weak second half. Everything our folks, as best they can tell now -- and remember, our backlog is right in front of our face. But we do look at quoting activity, which is up, and some of those jobs are a month out or a year out or longer based on where they're at in their project cycle. It's positive, so I don't have any reason to think that anything has changed dramatically with the fundamentals of the commercial roofing market.

[Ryan Merkel:]

Okay. And just last one if I can, just going back to the gross margins. Again, year-over-year you're in a pretty good inventory of position at a low-cost base. Plus, mix is on your side. So I'm still not quite clear why year-over-year, you wouldn't see gross margins, at least, on par with last year. And what's really the driver then as to why they're lower year-over-year? Is it because like cost isn't as favorable?

[Paul M. Isabella:]

Yes, I think without giving you too much detail, I think that's a piece of it. And the other piece is just as Commercial comes back, right -- and it's been down. It's been negative double digits here. As it comes back to what we think, there's going to be a mix impact there that'll drag down the rate just because of the gap between, resi and commercial.

[Operator:]

We'll hear next from Neil Frohnapple of Northcoast Research.

[Neil Frohnapple:]

Do you guys still anticipate that single digit organic growth for the full year? And if -- can you just provide a little granularity on differences between the 3 product groups, I mean, with non-resi maybe a little bit weaker this past quarter versus res? I mean, do you anticipate maybe res being above that mid-single-digit number and non-res maybe in slightly lower? Can you just provide some more color there?

[Paul M. Isabella:]

Yes, it might be difficult at this point to give you a lot of granularity by product line, but in general, if you look at the ranging that I gave, that $1.75 to $1.85, that the EPS piece -- and not to get off-track, but the EPS piece is slightly under the bottom of the range now, and it kind of matches up also to the bottom end -- lower end of the sales range, which implies about 3% organic growth if we hit that. If we go on the other side of the $1.80, that's when we get up closer to that 5% number that I talked about on the last call.

[Joseph M. Nowicki:]

And the both those numbers, 3% and the 5% are full year, so that's full year.

[Paul M. Isabella:]

Yes, full year. Obviously, the back half -- you're closer to -- at the lower end, higher single digits and at the upper end, you're up double digits, above 10%, to achieve those. And that's, quite frankly, contingent upon price realization and how strong the market's going to be for these next 5.5 months.

[Joseph M. Nowicki:]

Plus, the [indiscernible] underway as well.

[Neil Frohnapple:]

And then a follow-up on the non-residential commentary, Paul, you talked about you're confident about the residential price increases sticking. It's still too early to tell, but based on the quoting activity you've seen on the non-residential side, and I mean, typically distributers don't stock as much inventory of non-resi products. So can you just provide a little bit more granularity on maybe when we could see the non-residential price increase and just your conviction level there?

[Paul M. Isabella:]

Yes, I -- that's a more difficult question just because of the way the volume has been somewhat suppressed in Q2. I know the manufacturers committed to making up for any of their input costs, and they're very disciplined. Carlisle's extremely disciplined on pricing, and that helps. So my optimism level is above -- on a 0 to 10, it's above the 5. I think as volume comes back, I do think we will see price realization on Commercial. To what degree, Neil, it'd be very hard for me to tell you right now.

[Operator:]

We will go next to Thompson Research Group, Kathryn Thompson.

[Kathryn I. Thompson:]

Of the roughly $37 million increase in inventories in the quarter, that was -- $37 million was driven by acquisitions, but for the balance, how much of the dollar increase was driven by higher-priced roofing product that was purchased in the quarter versus anything else we should take into consideration?

[Paul M. Isabella:]

Well, I mean, the majority of the inventory build was for residential product that we started purchasing at the end of Q1 in December when the manufacturers announced the price increases that second week of December. And then -- and you saw slight increase in Q1, and then it continued as we received and purchased that same resi inventory in the quarter. I mean, in terms of commenting on whether it's high priced or low priced, we don't get into that level of detail except to say that as all distribution typically does every year, when there's a price increase, they purchase ahead of the price increase, and then as the increase goes in, you have advantaged inventory. If it's a 8% increase, of course, you have that advantage as you're selling through.

[Kathryn I. Thompson:]

Some of the feedback we've gotten from independent distributors this year is that the ability to buy roofing products in advance. The price increase was lower this year relative to last year and previous years. Did you see that trend this year?

[Paul M. Isabella:]

No. Now our ability to buy was only gated by our ability to buy, meaning our desire to say we either want 10 million more, 1 million more or 40 million more. The manufacturers, for the most part, as you look at them in total, have had the ability to ship product and the ability to provide product during the quarter at the pre-price level -- pre-price increase level.

[Kathryn I. Thompson:]

I know you've answered a few questions on the May price increase but just one follow-up on that. Is there anything structurally in the industry regarding demand that would lead you to believe that, that price increase wouldn't be successful?

[Paul M. Isabella:]

No, I don't think so. If I saw or felt and my folks -- this isn't just me obviously. There's a lot of data points we pull -- that there are something, some underlying issue with either the economy or the whole thesis of re-roofing, it didn't work all of a sudden, then maybe. But no, the industry fundamentals are the same. A large portion of what we sell goes to re-roof. Housing market continues to improve. We see it in different parts of where we do business. And no, I don't think there is any fundamental weakness that would prevent. The only thing that could happen is if demand for some odd reason wasn't as robust as we think it's going to be because of all the weather and all the pent-up demand not just from weather but just from the last few years, doesn't occur, maybe has occurred in '10, but we don't see those dynamics duplicating. But again, I can't predict the future with any high degree of certainty, so we'll just have to work through these next 4 weeks to 6 weeks.

[Kathryn I. Thompson:]

Sure. And final question, any change in incentives offered by manufacturers this year versus last year?

[Paul M. Isabella:]

Could you repeat that. I'm sorry, you kind of...

[Kathryn I. Thompson:]

Are there any changes this year in incentives offered by manufacturers versus last year?

[Paul M. Isabella:]

Yes, I mean, we typically have never commented on the level of incentivized. It's so proprietary for all distribution. Suffice to say, pull myself back a bit, right, we're a big company. We believe we have an outstanding purchasing group, and that's not just the corporate group but the entire executive team and the team out in the field, and we think we buy effectively. But in terms of talking about comparisons year-over-year, that wouldn't be appropriate.

[Operator:]

David Manthey of Robert W. Baird.

[David J. Manthey:]

First off, on the current tone here, you got residential revenues flat versus what amounted to pretty perfect weather last year. And I'm just -- as I'm looking at that and the implications relative to the main part of the selling season, it looks pretty positive. And then, Paul, you're basically endorsing the -- with a range but the same level of guidance as last quarter, and I'm just wondering what the moving parts are there. Is that because of the -- is that the pricing, like it's pushed out maybe a month longer than you thought? Or I mean, how are you thinking about that? It looks like this is a very positive demand sign early in the year, and I'm just wondering why that is.

[Paul M. Isabella:]

Yes, it is -- Dave, we were pretty pleased when we looked at -- when you just say -- obviously, when you look at the raw number as a standalone, you'd say, "Geez, it's an yawner." But then when you go back and remember what the heck happened last year when we have the tremendous, especially on the residential side, huge residential growth. And then we kind of pinch ourselves and go back to '11 and see the changes even from '11, not just on gross margin and sales but also on SG&A percentages, and they're all favorable. I think that you hit the nail on the head, but one of the driving influences for me right now is winter's just taken longer to get on track. I mean we had snow in April in the Midwest, in Denver. And I'm not one to talk about weather, but it's just really that and the weather conditions that just kind of pushed things out a bit. So I'm optimistic that there's pent-up demand as a result of that. But the year, we're into May now, and there's only a number of months left. So I want to be a realist on the side of how much price is going to hit, when is it going to hit and then how much of the pent-up demand really does come out. And that's the reason for the range.

[David J. Manthey:]

Okay, fair enough. And then on the -- not to keep hitting on this, but the gross margin going forward, you talked about the non-res business coming back and that would only have that type of negative impact if the mix changed, meaning that non-res would be growing faster than residential. Is that your expectation, that non-res is going to be stronger than residential?

[Paul M. Isabella:]

Yes, that's the view right now because it's been so pushed down for the last number of quarters that we've had. Maybe it's 3 where we've seen that negative pushback after the original, I think, 8 quarters of double-digit growth we saw.

[David J. Manthey:]

Right. Okay. And then finally, again, on the non-res business, I'm just -- I want to check your head on, do you think that's a good business? I mean, when you think about capital investment or acquisitions, I mean, does it factor in for you? And I'm just wondering, do you have the right products in the right places and again, just underlying all of that. Isn't it good business? Or is just something that you need to be in because you're in the roofing business overall?

[Paul M. Isabella:]

No, not for us. Non-res business is an excellent business. It provides -- especially, Dave, when we match -- when we mix it up in a branch that's got the other products, it really helps the SG&A piece because you can do multiple deliveries. It expands your customer base, some that do cross-over work. And the gross margin belies what we can do on the operating income side because the cost to service is so much lower. We -- salespeople cover bigger territories, have bigger budgets. There's a lot of products that are delivered direct versus truck delivered out of our warehouse. So no, I think -- and when you look and which I do, we look into the -- deep into the numbers on operating income for commercial businesses. It can be and in many instances, it's higher than the branches that are all residential. So no, it's a great business, and it helps buffet changes in demand of the other products. And that's why, for instance, Canada, historically, our -- the legacy piece of Canada on the East portion of Canada has been commercial, and we're trying to mix up residential. But they've had historically extremely high operating income because they just know how to run that business and the cost of service is very low, and they're very good at it. So that's great business.

[David J. Manthey:]

Okay. And then final question for me, just in terms of you were looking to move non-residential products into residential-only locations and vice versa. I know you had some early successes with that. Based on what you just said Paul, is that something where you're looking to accelerate that effort this year?

[Paul M. Isabella:]

Yes, I think especially as the selling season takes place, the Midwest has really pushed extremely hard to start up -- jumpstart their commercial business, and they've been relatively successful, albeit at a smaller level. And then you have the West Coast where we've done a couple of acquisitions in the last year that were predominantly commercial, and we're pushing extremely hard to put residential in there. Same with North Coast, heavy great commercial business, and we've been adding shingles, actually, for the last 5 years. So the percent now is over 25% residential there. Yes, we're going to continue that Dave. It makes a lot of sense. Same for Florida, where we had a heavy commercial business. We're pushing very hard on the residential.

[Operator:]

Up next, we have Sam Darkatsh from Raymond James.

[Joshua Wilson:]

This is Josh filling in for Sam. I wanted to get a little bit more specificity on the mix of new construction that you're seeing in your sales, residential versus nonresidential. What's the mix within each of those?

[Paul M. Isabella:]

Yes. It's about the same, and it changes by geography. For us right now it's around 15% or roughly.

[Joshua Wilson:]

For both, even with the strong...

[Paul M. Isabella:]

Yes, there seems to be a little more steam on the residential side. There's no doubt. As you look at different geographies. I won't get into a lot of detail, but we're definitely making progress on the residential, on new construction side, probably quicker right now than commercial.

[Joseph M. Nowicki:]

But I think in total, that overall mix hasn't changed over the last few years. It's been pretty constant.

[Paul M. Isabella:]

Yes, the historical number for both is a little higher historical going back before the '08 problem areas with the recession where it was over 20% to 25% for both, and it dropped off, we think, in the 10% range. We don't track every single job. That wouldn't be real productive for us or for our customer base.

[Joshua Wilson:]

And then is there a target for inventory that we should be looking out for the end of the fiscal year in terms of dollars?

[Paul M. Isabella:]

Yes, we typically don't put out targets. There's no doubt that in our second quarter, inventory increases, our turns were down into the low 3s. That will -- the turns will improve. Inventory will decrease. It's already decreased since the end of March quite a bit, and will continue that trend, always though with a first thought. We got to make sure we service our customer base, so we will have the needed inventory on hand. But it naturally just bleeds out as we go through the end of the year. But we've never talked about a target.

[Joshua Wilson:]

Okay. And then just to fill in a blank here, you talked about the spread in gross margin between residential and non-residential. What's the spread of residential versus complementary?

[Paul M. Isabella:]

That's right. Let's say it's in the middle of those 2 roughly.

[Operator:]

We will hear next from Keith Hughes of SunTrust.

[Keith B. Hughes:]

Questions back on non-residential not for near-term demand, but are you getting indications from contractors building business, building plans, things for later around the year, things of that nature, is that being seen by your folks in the field?

[Paul M. Isabella:]

Yes, there is more optimism about the activity as you move out into the future. I know specifically Carlisle is very positive about not just normal activity because roofs expire in the average 17 years, but also they believed there's still a lot of pent-up demand commercially, not necessarily new construction but re-roof that will occur. So yes. And I think that, Keith, I think that kind of parallels what I said earlier about the quoting activity we look at, which we see across the country. That our people do. Estimating activity is up and that's usually not for jobs necessarily next week, but they could be out 10 months, 6 months.

[Keith B. Hughes:]

Is that kind of the range, 6 months to a year when you would -- when you start see when quotation activity moves up?

[Paul M. Isabella:]

Yes, but again, there's jobs also that gets -- it's somewhat of a moving target. There's jobs that translate, jobs we estimate now that translate into sales within a couple of weeks.

[Keith B. Hughes:]

Did the shorter-term ones tend to be smaller than the longer-term you're referring to earlier?

[Paul M. Isabella:]

Yes, typically, right, just because the inherent complexity of a larger building with more hands on it, building owner, architects, specifier, that development process. And then if it's multiple buildings, it's going to take longer typically.

[Operator:]

And that concludes the questions. Now I would like to turn the call back over to Mr. Isabella for any closing remarks.

[Paul M. Isabella:]

Great. In closing, let me go over a few of the highlights, and these are repeats. Adjusted EPS for the quarter ended at minus $0.02 versus $0.07 in 2012, and for the full year, as we said, we feel comfortable the range of $1.75 to $1.85. Overall, gross margins were solid ending at 23.9% for the quarter, up over last year. Residential sales for the quarter were flat, while Commercial were down 9.8% and again, not entirely surprising given the strong comparisons we were up against from last year and the overall harsh winter weather this year. Incremental sales from all of our recent acquisitions should total approximately $230 million in 2013, and as I said, the price increases are still working their way through the market, and we'll have a much better idea of the extent of those increases and the time frame. I'm still very hopeful and positive that they will be realized, and we will attain those. And our acquisition pipeline is very active, and we're confident we will make additional investments in the near future. As always, I'd like to thank the employees of Beacon and the support of our investor base. We're working very hard to execute our business plan. Thank you for your interest in our company, and Joe and I are available for any other questions you might have here in the Peabody office. Thank you, and this concludes the call.

[Operator:]

Thank you. Again, that does conclude today's Beacon Roofing Supply conference. We thank you all for joining us.