Beacon Roofing Supply, Inc.
Q3 2013 Earnings Call Transcript

Published: 9 Aug 2013

[Operator:]

Good morning, ladies and gentlemen, and welcome to Beacon Roofing Supply's Fiscal Year 2013 Third Quarter Conference Call. My name is Tiffany, 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 Litigation Reform 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 today, August 9, 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 financial slide presentation on the Investors section of its website under Events & Presentations that will be referenced during management's 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, and good morning, and welcome to our third quarter earnings call. We certainly had a very challenging quarter with a number of dynamics impacting our results. However, we still delivered solid results in many parts of our business. I'll go over a few of those. We're still very focused on our overall growth and business plan. From a total sales perspective, we did achieve record third quarter sales, ending up 12% versus 2012 at $627 million. This was fueled by our solid acquisition growth and by 1.2% organic sales growth. This was below our expectations but considering the difficult storm comparisons and general market softness, we are pleased the organic rate is positive. For the quarter, we delivered $0.55 of EPS versus $0.62 of adjusted EPS in 2012. These results also came in below our internal expectations. Harsh wet weather impacted a good portion of the quarter in most of our footprint. Owens Corning and Carlisle mentioned this on their recent earnings calls. There was a reference to this being the wettest weather in 50 years on the Carlisle earnings call. Late winter snowfall in the Midwest and Mountain region and rain during most of the quarter in most regions prevented contractors from performing work. Rain days year-over-year for most regions were significantly up nearly double in most major markets in the quarter. Adding to the sales shortfall was a lack of severe weather, specifically hail, in 2013. Major hail events in our Q2 and Q3 were down nearly 30% over last year. That, coupled with the 2012 hail occurring in 2 of our most dense regions, a southern portion of our mid-Atlantic and the Midwest, made for tough comparisons. Lack of hailstorms and less available roofing days caused demand to be much lower than expected. As an indicator, manufacturer shipments of shingles into distribution were down 32% in the April to June period per industry data, and first calendar half shipments into distribution were down 12%. This is an indicator of market weakness during the quarter in calendar first half. This weaker demand impacted our ability to achieve higher levels of price in the quarter, specifically on asphalt shingles. This, combined with shingle input cost increases from the manufacturers, hurt gross margins. Some of this result was offset by price gains on our Commercial and Complementary products. On the other hand, other elements of our business continued to improve, showing our commitment to continuous improvement. Let me mention just a few of them. First, cost control during the quarter was very good, coming in at 15% of sales for our existing markets, down from 15.9% last year. Also, operating margin came in at a very strong 7.6% for the quarter, which falls in the upper end of our stated range. We're also very pleased about acquisition integration as we delivered $65 million in sales and 3% operating income, including $1.7 million of amortization. Without these expenses, the acquired markets delivered 5.6% operating income, good results given the newness of most of our acquired markets. And our greenfield push continues as we opened 2 branches in the quarter. That's 3 new openings through 3 quarters, with a fourth added in July. We still plan to open approximately 10 in fiscal 2013, and are on track to open 20 next year, which is an increase from what I stated on the last earnings call. And finally, bad debt continues to be another bright spot as the work we have done improving this process shows in the results. Now, as I've done in past quarters, I'll give a little more detail on sales, gross margin and EPS. With regard to sales by month, Q3 organic sales were as follows

[Joseph M. Nowicki:]

Thanks, Paul, and good morning, everyone. Paul did a great job summarizing our financial and operational performance for the quarter. I'll highlight a little more detail on a few key financial results and metrics that are contained in our earnings press release, the Form 10-Q filing and the third quarter slides that were posted to our website this morning. Total sales for the quarter increased 11.9% to a third quarter record of $627 million. The majority of that growth came from acquisitions that added $65 million to our revenue for the quarter. Our fiscal 2013 third quarter organic sales increased 1.2%. Our sales in existing markets by product group increased as follows

[Operator:]

[Operator Instructions] At this time, we will take our first question from Ryan Merkel with William Blair.

[Ryan Merkel:]

So the first question, just want to start with the pickup you saw in July. I think you said it was 5% on a daily basis, and you're kind of guiding to 6% to 8% for the fourth quarter. Is this a broad-based recovery across all the product categories? And then just confirm, is this -- and this is mostly volume, right, at this point?

[Paul M. Isabella:]

Yes, it'd be very difficult for us to calculate price this quick at the end of the quarter -- the month. Yes. But we believe it's volume.

[Ryan Merkel:]

And is it broad-based? Is it Resi, Non-resi and then Complementary Products that are all picking up here in July?

[Paul M. Isabella:]

Yes. If you look -- as you dig a little deeper into the July results, it is across all of the elements. There is still, though, as I mentioned even in July, and that's part of the concern for Q4 in the very near term, is the impact of last year's storms to become even more, I guess, a drag on the quarter, especially in, as I said, the southern portion of the mid-Atlantic, Midwest, Upper Midwest. There's still an awful lot of resi drag there. But yes, to answer your question, at least July was better news, up in total 10%. But again, with that extra day, it's 5%.

[Ryan Merkel:]

Okay. And then just moving to the price comment, I think you said that distributors are now restocking at the higher OEM price increase. Was that the August 1 price increase? That's the first part of the question. And secondly, when would this actually go through the contractors, though? Because my guess is, inventory is still a little bit high out there in the channel with some of the lower-priced product still out there. So how long might it take to even be selling to the contractors at a higher price?

[Paul M. Isabella:]

Yes, good questions. Yes, in terms of August -- no, this is not -- this has nothing to do with the August price increase. If anything, I think that potentially could be pushed out into September or not materialize at all. That's my view. This is from the prior increases, the 2, the one they did in December then the one they did later on set for the March, April time frame. And as we said, we saw -- what we did see, at least some good news, one point of price attainment in the quarter where we really needed to see 5 or 6, I can't -- it's difficult for me to comment, Ryan, on the inventory level for the competitors. The view for the last 4 weeks plus has been that there's just been an awful lot of reloading. So you could be correct about distributors having inventory available, more inventory available. But again, you would assume, again without looking into the manufacturers' P&Ls or their competitors' P&Ls, that they're reloading at a higher level -- higher pricing level. Therefore, they're going to be more willing to push it through. To your question about when should we see it, I -- when we did the second quarter earnings call, I thought we were going to start seeing price movement, bigger price movement, end of May, kind of push that back as I did roadshows through the end of June. And then what materialized was only the 1 point. So if you ask me now, I'd say geez, within the next 4 weeks, we should see prices meeting -- right now, contractors need to see higher prices. That's the bottom line. Because manufacturers -- as they say, their input costs are up, and they pass price along to the channel. So the channel should put -- push those prices down to the contractors. That's what we've done historically, and we're working real hard in every market to raise prices and show price realization. So as far as I'm concerned, we should see more of it now realistically based on what's happened in the last quarter, another 4 weeks, 6 weeks, something like that.

[Ryan Merkel:]

Okay, that's helpful. Yes. Owens Corning did say that a lot of the distributors were rebuying at the higher price. So potentially, it does go a little faster.

[Paul M. Isabella:]

Yes, it is good news.

[Ryan Merkel:]

Okay. And then last question, you had a little bit of a squeeze, as you mentioned, on the Resi side, so you had a kind of flat pricing there in the quarter. So did you absorb, what, 5 points from the OEMs? Is that the spread? Is that why the margins are down there? Or what was really the spread? What did you actually absorb from the OEMs versus what you passed on?

[Paul M. Isabella:]

Yes, I -- that's a relative -- looking at approximates because we don't have an exact number. It's in that 5-point range that we absorbed that we would normally had pushed price through the channel as we went through the back half May, June time frame. And so one of our thoughts, and that's why the guidance, I ranged it $1.50 to -- $1.50, $1.60, is that, that normally would get pushed through. And if we could see some of that realization in the fourth quarter, that helps us obviously with our numbers for the quarter.

[Operator:]

We'll take our next question from Keith Hughes with SunTrust.

[Keith B. Hughes:]

On the acquisitions, the -- you had some of them in the fold for a while, and their operating expenses are a good bit higher than we see at the existing Beacon operations. If you move forward 12 months in the future, do you think you can get those down closer to what we traditionally see from Beacon operations?

[Paul M. Isabella:]

Yes. I think we historically said that it's a 3- to 5-year run to normalize acquisitions. I think, due to the efforts of our team, teams in the field, we've been able to accelerate that. So I think in 12 months, the cost profile will start -- get closer to normalized and, of course, there'll be variations by the fact that one of those acquisitions, which is a fairly healthy chunk, was heavy commercial. They're naturally going to have a lower cost base, a lower also gross margins. So I think we will definitely see more normalization. As I said in my comments, I was quite pleased -- not totally pleased with -- when you strip out the amortization expense at closer to the 6% range. I think as we go through the next 12 months, if we didn't do any other acquisitions, that would move up in the 7% to 8% range. Gross margin for the most part has been reacting quite well in the acquisitions, and part of what you saw was the full quarter impact of that Western acquisition that was heavy commercial pulled down the number a bit. But we still have -- remember, we did 2, 3 of those acquisitions in the late November, late December time frame, so they're still relatively new. We did the IT conversion a few months after acquisition. And so now, we're really getting into the meat of the -- all the transition that occurs, which again typically does not take 6 months. Historically, it's been over a year. So, yes, I think within 12 months from today, all things being equal, no change in other acquisitions, we should see for sure that cost rates get closer to the -- our annual 17% -- high 17% rates.

[Keith B. Hughes:]

I remember, you referred to the 6%, you're saying that the acquisitions were doing 6% margin, excluding the amortization. Is that correct?

[Paul M. Isabella:]

Yes. $1.7 million in the quarter. Without it -- with it in -- the expense in was 3%. You pull it out and it goes to 5.6%. So it's just another way we look at it because no one -- as we go through the 7-year bleed off of amortization, it lessens. Right? And there are -- in that cost number, there are naturally start-up costs that still go on because we have folks out there working on the acquisitions, making changes, getting them up to speed, in terms of process control, things like that.

[Keith B. Hughes:]

Okay. And final question on the commercial arena, can you give a sort of a feel of what you're hearing in the channel in terms of upcoming work, project and heavy things like that?

[Paul M. Isabella:]

Yes, good question. Carlisle talked a lot about it, obviously, they did on his call, and they're pretty optimistic in the back half. It's interesting. We -- I don't have anything different to say than what he said. Our markets have -- there's no doubt, our markets have been pounded down even though we showed flat growth year-over-year. But some of our markets have been pounded down because of the weather. So there's this view of a 6 to 8, even 10-week lag and some of the normal work popping out. If you believe that, which is another data point, that means we could see some increased volume in our fourth quarter, and then because we don't stop at year end, right, in October and November. So that's one element. So I don't disagree with what Carlisle said. I also do see, and we do see in general, pressure coming from municipalities and any kind of state-funded public work where there's been quite a bit of push off last quarter, even through July. That being said, we see the trending a little better in July commercially, and we're fairly optimistic. But again, those are opinions based on market data triangulation and talking with the manufacturers.

[Operator:]

[Operator Instructions] We'll go to our next question from Michael Rehaut.

[Michael Jason Rehaut:]

First question on the gross margins. You noted that you expect to get a little bit more in terms of the price pass-through in the upcoming quarter, yet your guidance was for 23% to 23.5%, and that's a little bit below the 23.5% that you hit on the third quarter. So the question is, you would expect it to be at least equal to the third quarter unless perhaps the margin kind of degradated throughout the quarter and you're -- even if you're getting a little bit back, you won't get to the average for 3Q? Is that the right way to think about it? Or...

[Paul M. Isabella:]

Yes, I think thinking about it in the absence of any -- obviously, any price statement in Q4. That's the way to think about it. And when I talk about 23%, 23.5%, $1.50, $1.60, we can go through the sales estimate, maybe 6.70, 6.80, really very difficult to forecast sales, right? We can do all that. I didn't put any price in the guidance numbers I gave. And so there's a little bit of range in gross margins. If we get price, it could be -- it could help us. Some of the drag that occurred in the June, a little bit in July, although we don't have July final numbers yet, time frame could be buffeted by an increase through the end of August, September, get us closer to the 23.5%. Right now, I'm not prepared to say we'd go above 23.5%. But again, as I said in the prepared comments from 6 -- oh, geez, I don't know, 6 months we've been talking about -- I thought realistically the back half was going to be low 24s. But, yes. And just based on input costs, inability to get price in the market, competitive pressure, it has dropped down to the 23.5% for the quarter.

[Joseph M. Nowicki:]

And this is Joe. I would add to that, that there's 3 things over there that are going to drive the margin. Right? The price, the cost and the third element being the mix of the products in there as well, too. And Paul talked about the price piece being probably pretty consistent, not having a lot of expectations for price. The cost part, we already talked about what's happening to the input cost piece, so you know the direction that'll have on it. And the third one is the mix as well, too. At this point, we're not anticipating any significant change in the mix as Paul described.

[Michael Jason Rehaut:]

Okay. So that's helpful, though. So obviously then, it's kind of along the lines of that idea that likely -- let's say the June gross margin was probably well below 23%. Is that fair?

[Paul M. Isabella:]

I wouldn't say well below. No. And we don't -- we haven't given breakpoints on our gross margin, but it was lower than April's rate but not significantly, Michael.

[Michael Jason Rehaut:]

I appreciate that. And the second question just on the organic sales growth outlook. I guess 10% in July, 5% on a same day basis and you're looking for 6% to 8% for the -- for 4Q. Is -- on a total days basis, is the fourth quarter have the same amount of selling days as a year ago? And do you expect the organic sales rate to remain similar throughout the quarter despite September being a little bit of a tougher comp?

[Paul M. Isabella:]

Yes. I don't -- I mean, as you look at August and where we were last year, it wasn't on the same days. It wasn't unbelievably up or down, although we did see the trending now in our fourth quarter going down. I think we could see -- and it's so hard to predict sales, right, because our backlog is a couple of days a week at that and Commercial in front of our face. I think we could see the same kind of momentum but the difference is August and September on a same day basis, is going to be greater than what July was. As I said, July was fairly strong if you just look at the numbers at 10 points, at 5. So we're going to need to do 8% to 9% August and September and with a slight drop-off in August from last year and then the flatness of September on a same base. It's doable.

[Operator:]

We'll go to our next question, Ken Zener with KeyBanc Capital Markets.

[Kenneth R. Zener:]

Paul, you're making very interesting comments this quarter on the price dynamic that you guys are receiving versus what's going out in the channel. So I just want to be clear, when you talked about the 1% price for the company, 5%, I'm assuming the bulk of that is happening in the Residential segment. Is that correct?

[Paul M. Isabella:]

Well, when you look at the weighting of Resi and you can see the splits in the Q, I think Resi sales were $284 million or so in the quarter. I mean, it's certainly a big chunk of it. Commercial was relatively flat. And Complementary was up [indiscernible]. So...

[Kenneth R. Zener:]

Right. So the reason I framed it that way is that it seems as though -- if you didn't get the price relative to cost and -- that your gross margins more in that Residential would have gone down. So can you just update us on the spread between the Residential and the Commercial, if you will, as you've done in the past? And then talk about the dynamic. Have you seen this occur, whether it's a disconnect between the price and the volume? And was that more associated with regional pressures, meaning where, in the Midwest, you were down a whole bunch, pricing was weaker than another area?

[Paul M. Isabella:]

Yes, I think there's no doubt -- to answer the last part of your question, there is more intense regional pressure on the Resi side that keeps price pushed down. In total, our Resi price attainment was up about 1.5 points. We have seen in the past increased material costs coming in. We typically offset those with some form of price, whether it's in Commercial or Complementary. But this isn't that unusual. Some of this, we believe, although we really need to see and go through the fourth quarter, some of it is timing, although we're going to continue to watch it. I think the spread has really not changed, and I don't have -- if you're talking about the gross margin spread, we've been talking about a range of 1,000 to 1,200 basis points. I mean, I don't think it changed that much, a little bit in the quarter. But again, I don't have exact numbers sitting in front of me on that spread. So, yes, the -- we did see decent, albeit with a competitive pressure, decent Resi price attainment at 1.5 points. We wanted to be 5 plus. We saw some Complementary, we saw basically flat Commercial. And then as a result of the input costs going up, that -- and a little bit of mix, that's kind of where the GM dropped.

[Joseph M. Nowicki:]

This is Joe. I'll add just a little bit more color there as well, too. As Paul had said, we talked about in the call the Commercial margins, both year-to-date and also for the quarter, were pretty consistent. So on the Residential side, your point's right. The gap has narrowed a little bit. Not as much on the year-to-date, but certainly in the current quarter where we've seen the residential margins come down. So the gap between the 2 of them has gotten a little closer this quarter.

[Paul M. Isabella:]

Yes. Part of our challenge, I think, has been the fact that last year, between storm volume and overall demand, however you want to define demand, was so healthy, the buy price was very advantageous from the manufacturers' OC. I alluded to that on past calls. And that pushed our gross margin up quite a bit, and that's why we really never said publicly in any form that we were going to hit 25% gross margins this year. We kept the range the same, 22.5% to 24%. In fall, we -- as I said a couple of times now, that we'd end up maybe a little above the 24% in the back half. But it's ticked down just due to the competitive pressure and -- this has happened before, and I think we're just going through a little bit of a cycle. That's all.

[Kenneth R. Zener:]

No, I definitely agree. And if you could just -- would you say that wherever you are in Residential and the spread of that to Commercial, that we're at a more normalized level right now? And second, there were multiple price increases. The April increase, which is what you're saying, you're seeing one real increase in residential shingles this year? And there's 2 announcements. The first one is what you are saying is actually in effect. The second one, it doesn't appear to be the case. But you did see a price increase from the distributors -- the manufacturers.

[Paul M. Isabella:]

Yes. I don't think -- I can't say that the spread is more historical. For this quarter, it could be, as Joe alluded to, a little tighter. But we have not tracked it in definitive exact numbers. We've given a range of the difference between Commercial and Resi, as I said in that 1,000. It did trend up a bit to 1,200 basis points. It's tighter this quarter. But again, I think in the future, you're still going to have that very similar 1,200 basis point spread as we go through time.

[Operator:]

We'll go to our next caller, Kathryn Thompson, Thompson Research Group.

[Kathryn I. Thompson:]

Just want to pull the string a little bit further on pricing. Manufacturers are getting pricing. But based on feedback we've gotten from the channel from our industry contacts, that obviously -- and you saw today, distributors are having less success in passing on pricing to their end customers. How much of this is a function of customer pushback, or perhaps, to maybe more of your peers, a fear of losing that incremental volume and distributors holding back from passing on the increase?

[Paul M. Isabella:]

Yes. I think they're all intertwined, Kathryn. I think, ultimately, in any market situation, at least for us, where you have softer demand, and especially -- I mean, if you really see when we going to our store markets, where we had hellacious volume last year, that we've probably got our unfair share of work. And now a lot of those homes have been re-roofed, demand is down. So contractors have less work, they have more time to shop. So it ultimately starts with them pushing back and shopping. So that then turns into who's going to lose share? Who's going to gain share? So I think, although our results certainly aren't anywhere near where we thought they were going to be, I think framed with where manufacturers shipments have been through the first calendar half, let alone the second quarter where they're way down, and some of our markets where we see volumes in general, the amount of work we see available, not just our sales way down, I think we did relatively well, even getting 1.5 points in containing the increases from the manufacturers at that level. It's very difficult to gauge because I don't know what any of our competitors had done. But I think, quite frankly, without trying to settle for our results because we certainly are not satisfied, I think we still did relatively we'll. But I think it all starts with contractors having less work, more time to shop and putting more pressure. And that's been the way it's been ever since I've been here.

[Operator:]

And we'll take our last question from Sam Darkatsh with Raymond James.

[Sam Darkatsh:]

A couple of questions. Most of my questions have been asked and answered. Joe, I guess both these questions are for you. The inventory -- ending inventory per branch in dollars was up 3% year-on-year. Do you have a sense of what that might have been on a volume basis if you -- I'm trying to get a sense, were you guys also by the end of the quarter buying at the higher prices? I'm just trying to get a sense of whether your commentary around the channel inventory and the shop participants having been buying at the higher prices was reflected in what you guys were seeing also.

[Paul M. Isabella:]

Yes. At least, Sam, on the second part of your question, it wouldn't be appropriate for us to comment on what we bought and how we bought in June. There is -- our inventory is up a bit because we had to restock for customer service reasons. But if you look at the inventory, I think the $50 million increase year-over-year, $35-million plus of it is acquired market-based. Joe, I don't know if you want to take a swing at that 3%?

[Joseph M. Nowicki:]

No, I think that's the biggest part of the answer to the question, Sam, is that of the $50 million increase, $35 million is from the acquired stores part of it. So if you really take that into consideration, you might end up at a -- your math, I'd have to work through that with you. Your math might tell you a different story on our other existing -- the other stores that we have. But...

[Paul M. Isabella:]

But, Sam, specific to the volume comment, I mean, we haven't calculated that. What the 3% becomes -- it's probably going to be 0 or less if you factor in any COGS increases.

[Operator:]

That concludes the questions. Now I would like to turn the call back over to Mr. Isabella for his closing comments.

[Paul M. Isabella:]

Great. Let me go over a few highlights of the call today. Most are repeats, but I think they're worth repeating. Sales for the quarter ended up a record $627 million, which means we continue on our growth curve. As we said, adjusted EPS for the quarter ended at $0.55 versus the $0.62 of last year. And for the full year, we believe we'll end up in a range of $1.50 to $1.60. Obviously, that's dependent, as I said, on sales performance and gross margin performance, pricing performance. We believe we are able to totally control costs and will continue to do that in the quarter. Our overall gross margins, as we said, ended at 23.5%, down from the prior year, impacted by weaker demand, tougher competition and some cost increases. Operating margin for the quarter was a very strong 7.6%, and we'll continue to push at -- work at the higher -- getting into the higher end of our stated 6% to 8% range. Residential and Commercial sales for the quarter were flat, while Complementary was up 5%, which is good news. Incremental sales from acquisitions was the $65 million I mentioned. With the solid operating results, they're doing quite nicely with the integration process. And as we've talked, most of the questions referenced, price increases on shingles have not worked their way through the channel yet. I'm confident they will, we just have to continue to push price and taking a hard stand, quite frankly, on raising prices in every one of our markets. Our acquisition pipeline is still very active, and we're confident we'll make additional investments in the future. As I also said, we're focused on opening approximately 10 branches. It could be 9, it could be 11 in 2013, and we're extremely focused and have done a lot of preplanning by location on opening 20 in 2014. These branches will help ensure our organic growth well into the future. Now our business model has not changed. The market and market dynamics have not changed. We will continue to grow. We will continue to focus on cost control and gross margin growth. We will continue to drive best practices across the company. Our market is large and growing and serves mostly replacement business. New construction is growing, and that's good. There will, however, be periods when weather and market conditions impact results positively and negatively. The key for us is to continue executing our strategic plan and provide compelling shareholder and customer value. And in closing, as always, I want to thank the employees of Beacon and their support -- and the support of our investor base. We will continue to work on executing both our short-term and long-term plans. Thanks for your interest in our company. Joe and I are available for any other questions you might have. Thank you, and this concludes the call. Have a good day.

[Operator:]

And that concludes today's conference call. Thank you for your participation.