Beacon Roofing Supply, Inc.
Q4 2013 Earnings Call Transcript

Published: 26 Nov 2013

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Beacon Roofing Supply Fiscal Year 2013 Fourth Quarter and Year End Conference Call. My name is Lexie, 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 future financial performance of this 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, November 26, 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 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 fourth quarter and full year earnings call. We've made progress on a number of business deliverables, most notably sales growth. Total sales growth for the quarter was strong at 14.3%, fueled by organic growth of 6%. The sales results are a record for a quarter and full year. Our team did a great job with growth. Earnings for the quarter ended at $0.56 versus $0.60 last year. This was below our expectations, but considering the competitive price pressure we felt, we feel good about our progress. The Q4 gross margin ended at 23.1% versus 25% in 2012. The mid-Atlantic and West regions continued to deal with the lower -- with lower demand being on the backside of storm volume they enjoyed in 2012. Those markets are beginning to recover. In the near term however, the lack of normal demand creates a much more competitive environment, as we have said, as there's less work because of pull forward as contractors and distributors compete for the same work. Cost control was another strong point. We had very solid results in the quarter with our existing market costs ending below 16% of sales over a full point lower than last year's rate. Costs were flat year-over-year on a dollar basis, with a 6% organic growth in the quarter. Good leverage and good performance. We continue integrating the recently acquired companies and are making good progress focusing on customer service and operational improvement. We will continue this effort in 2014 and beyond. As we have said in the past, we typically view the new acquisition integration process as a 3 to 5 year timeframe. We're still very active in the acquisition market. We continue to talk to numerous companies. We had a very successful year last year, acquiring McClure-Johnston of Pittsburgh, Ford and CMS of Northern California. It is difficult to predict when sellers will sell. We have the capital structure and operational strength to do multiple deals and will continue to work on executing these as we have in the past. In addition to the acquired markets, we continued to make progress with our growth strategy related to greenfields, as we opened up 7 new branches in Q4 ,which brings the 2013 total to 10, as we talked about on the last call. Another bright spot was operating cash flow, which came in at $76 million versus last year's $85 million. All of our debt measures are in excellent shape and position us well for growth in the future. Now as I've done in the past, I'll give a little more color 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. Now I'll highlight a little more detail on a few key financial results and metrics that are contained in our earnings press release, the fourth quarter slides that were posted to our website this morning and the 10-K that will be filed later today. Traditionally, we'd like to file a 10-K with the press release, but we moved up the press release date with this conference call to accommodate the short holiday week. Total sales for the quarter increased 14.3%, a fourth quarter record of $684 million. Half of that growth came from acquisitions that added $43 million to our revenue for the quarter. The other half came from organic growth. Our fiscal 2013 fourth quarter organic sales increased 7.6%. By product group, the increase was as follows

[Operator:]

[Operator Instructions] We will now take our first question from David Manthey with Robert W. Baird.

[David J. Manthey:]

First question, in terms of the current quarter, could you break down just -- so we're 100% clear on the price versus units by Res, Nonres and Complementary if you can do that for us. And then if you're looking at, say, 6% growth next year, could you give us a rough breakdown of your expectations on how that would breakdown between the 3 segments.

[Paul M. Isabella:]

Yes, Dave, in terms of the quarterly splits on mix, we don't have that. The price mix impact was in the quarter in this $3 million to $4 million range. More of the impact came on the input costs side as you measure year-over-year.

[David J. Manthey:]

Okay, you mentioned that the gross margin was most impacted by shingles, so I guess, that the Residential side was the one that was mostly impacted by a negative price.

[Paul M. Isabella:]

Yes, it sure was, yes. Again, price was that mostly that 1/2 of that 0.5 point. But we still have obviously COGS being impacted, some of it being the hangover from Q3 of the material we took in that was at a higher level, hence, we weren't able to get pricing out. For next year, we don't have the splits, although we view Commercial as potentially being above 5%. I do in this 7% to 8% range. It's interesting. The October splits on growth were pretty interesting. Resi was up 8%, Commercial was up 15% and Complementary was up 9%. I do think some of the Commercial growth in October could have been spillover from September. We had a little lower growth -- organic growth rate in September. We were hoping to get closer to $700 million for the quarter in total sales. We ended up at that 6%. So Dave I don't have it, the splits broken out definitively for next year by line of business.

[David J. Manthey:]

Okay. Then just to follow up, in terms of the difficulty you had passing price increases through to the channel, I'm just wondering if you could talk about how much you think that is just a temporary issue and if there's anything that's sort of structural that might be an issue there. And as it relates to that, at current levels of inventory that you see out in the channel, and then what might affect the company's gross margin to be either on the low end or the high end of the 22.5% to 24% next year as you think about the gross margin in the next year.

[Paul M. Isabella:]

Yes, good questions, Dave. I think no, there's nothing structurally that has changed at all in the marketplace. If you look at our gross margins through the years, they fluctuate. They'll fluctuate this winter as volume dries up because of that -- because of the weather, especially obviously in the Northern climates. I think the inventory right now is being bled by -- that's my view -- by most of distribution, and I think that's why the competitive pressure has continued from Q3 into 4. I wouldn't expect it to necessarily subside. Here we got what -- 5, 6 weeks left in the year and the weather is going to start. Folks are trying to burn inventory. Yes, I didn't mention our inventory, but we ended up at 2 50 versus -- or so, versus the 2 20 last year. '14 is at 2 50 and change was acquired markets. So we did quite well ourselves burning inventory off. So I don't -- I made also comments that we're seeing more firming than erosion as we do our own checks. So I'm hopeful that as it normally happened as we go through the winter and all of distribution does somewhat of a winter buy, that prices will firm as we get through our Q2, and we'll actually see price appreciation. We're going to be very, very focused, as you can imagine, on input costs and then on measuring our folks to obtain price just because of the fact that we took in costs during the year that we weren't able to translate into price out the door.

[Operator:]

And we'll take our next question from Ryan Merkel with William Blair.

[Ryan Merkel:]

So I just want to start with the quarter. You missed your guidance by about $0.01 for the quarter. It looked like that was on the OpEx line. Was that the reason? And then could you kind of explain why operating expenses are up so much sequentially? It just seemed a little out of line versus history.

[Paul M. Isabella:]

Yes, no, as we looked at the quarter, I had said that if we were closer to the 23% gross margin, we'd be at that "lower range" which I tabbed at $1.50 and, hence, the quarterly number. And obviously, we ended up right in that range, but part of the pain continued just on I thought sales were going to be a little bit higher, but it really -- the pain that we saw still is a result of the gross margin being just less than what we needed it to be to get above $1.50. I don't think from a existing market cost standpoint year-over-year we did quite well total. We still -- we are impacted by the acquired markets. But in the quarter, the acquired markets actually improved from where we were year-to-date at the end of the third quarter, probably in the 22% range of costs against sales. So there is nothing structurally that occurred in the quarter that would change any of that other than timing, other than the acquisitions, although as I said, the acquisition cost piece improved as we went through the year and it will continue to improve as we go through '14. We did the 2 -- about 1/3 smaller but 2 big acquisitions just about at the beginning of the winter, especially McClure-Johnston as we took them in, in November. So we incurred an awful lot of costs with very little sales upfront, and then we worked through the year to work down and integrate the teams.

[Ryan Merkel:]

Okay. So from your standpoint, it was more of sales at the lower end and gross margin at the lower end. It wasn't really an OpEx issue. That was in line with what you were thinking.

[Paul M. Isabella:]

Yes, we had -- remember, some of our regions had some hyper volume too, where we saw growth. And obviously, we fueled 6% organic growth on for the quarter, the same cost -- dollar cost year-over-year, which we feel pretty good about. There's always room, as you know, Ryan, as we've talked to improve on the cost side. So we will continue to look for ways. We will continue to drive down wasteful overtime and reduce costs, cut costs wherever we can to be as efficient as possible. But nothing structurally changed at all on the cost line.

[Ryan Merkel:]

Okay. And then moving to gross margin, can you just talk about the trend during the quarter because I think it started at a lower and I think you were hopeful that it would rise as the quarter progressed. And some of my checks indicated that prices have actually inched up 7 in the last 8 months on shingles while COGS remained flat. I was hopeful there will be a little bit of progress there, but just talk to what we saw in terms of the trends in the last couple of months, and then if you could even into October.

[Paul M. Isabella:]

Yes, I think in general, it's been flat. We thought the same thing that there was a bit of an uptick, and I can't get too deep obviously into our Q1 just because we don't talk at that level of detail. But as we went through Q4, that margin was relatively flat. It didn't -- it did not show a pop. I think your comments about pricing now, we would tend to lean towards agreeing with you because a lot of our checks, I mean, at this point now, not necessarily in the past, we're starting to see more optimism that market is firming. And that could be as a result of so many factors, many we can't see, such as inventory in the channel, any late year buys that are being made by competitors to reach gates, things like that, right? But we're -- there's more optimism now for sure than there was a month ago. There was 4 months ago, there was 6 months ago. As we got through the April/May timeframe and we realized we weren't seeing price. So flattish right through the quarter.

[Operator:]

And we'll take our next question from Ken Zener with KeyBanc.

[Kenneth R. Zener:]

I guess, if you could talk about this $3 million or $4 million mix. I'm just trying to understand, I mean, we're talking about price and input cost, and it sounds like price is kind of flat sequentially. So do you think -- I mean, the gross margin erosion first, what in the quarter was kind of a spread between Res and Commercial, if you would? And second, was the compression you saw if prices were flat really because of the higher prices you took in? And why do think that wasn't reflected? I mean, it's normal for people to raise cash for Christmas as the -- as we get into the slower selling season. So what don't you think that pricing pressure was happening to your smaller distributors?

[Paul M. Isabella:]

Yes, I'll take at least the spread piece. That hasn't changed. We talked about 1,100 basis points between Res and Commercial, and it moves, it floats, one going up in, the other going up or down. So we don't see -- haven't seen any huge change there. And then the last part of your question, I mean, I really can't talk to our competitors. I guess one logical answer would be that maybe there isn't as much margin sensitivity. But that would be speculation on my part. For some of the other elements of the mix/price, I'll let Joe talk through that for the quarter.

[Joseph M. Nowicki:]

Yes, I'll try to unpack your first question, which I think was trying to [indiscernible] quarter. I'm trying to understand a little bit of what drove that quarter-over-quarter decline in gross margin, right? So yes, it was down roughly around 2 points of gross margin. 3 key elements in there

[Kenneth R. Zener:]

That does. That was very good. I appreciate it. Now, could you -- where you saw -- because you were in different regions, what's the gross margin, or do you see a correlation between markets where it was more demand, therefore, wasn't slower, and you didn't see as much margin pressure specifically on the Res-side-related inventory? I mean, is that kind of a function of demand or is that really more seasonal in all your markets?

[Paul M. Isabella:]

Yes, I think it's more seasonal. I mean, of course, there are little micro pockets where we'll see hyper demand and then hyper gross margins. But I think in general it's more seasonally affected. And we certainly have areas that are growing strong, and it doesn't mean any of us in distribution can name our price. There still are competitive factors. We still have very, very informed and bright contractors, our customers. And so our whole advantage right, is the value add. So no, I think it's more seasonal than necessarily volume-related. On the sequential piece, if you look from Q3, whether it's overall or existing in the quarter, our margins went down, I'll say, slightly overall, 23.5 to 23.1 and then existing, 23.2 to 23. So the same forces were at work -- that were at work in Q3 kind of carried through in Q4, even with the stronger volume, which just points to a competitive market, which is an unusual for us.

[Operator:]

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

[Sam Darkatsh:]

Two questions. First off, the October Residential being up 8% is real encouraging, particularly in light of the fact I think, Owens Corning was mentioning that they were expecting the industry to be down in the mid-single digits in the December quarter. Is there a really onerous year-over-year comparison in November and December because of Sandy last year? Or are you picking up a disproportionate amount of share at least near term? How do we reconcile what you're seeing versus what your suppliers said?

[Paul M. Isabella:]

Yes, good question, Sam. I mean, I wish we could measure share more definitively. We're trying to -- we're going to dig in deeper as we go through time to see if there's some measure we can get at that would allow us to talk about that. No, our Sandy volume was virtually nil. And I think I said at the outset, I'd estimated $5 million to $10 million, and I think it's in that range that we realized $10 million, maybe a little higher. So there's nothing there. And then on a -- I don't have the exact splits from last year, but I think we were down in November and December organically. But again, Samuel, that can -- any of the numbers fluctuate right from month-to-month just based on what work is being let. And then, of course now, especially as we get closer into the long holidays, and then winter, depending on what happens with the weather, that could also influence sales.

[Sam Darkatsh:]

Last question. I think one of the other questioners was mentioning this, too. The wide gross margin spread expectation for 2014. I mean, you're, at least for '13 you're already at the higher end of that range, and you're talking about trying to work gross margins higher. What would have to happen and how realistic is it for you to actually come in around that 22.5% to 23% range, that the low end of that range, it seems a pretty onerous at this point. And then I would think somewhat unlikely. I'm just going to get a sense of that.

[Paul M. Isabella:]

Yes, I wouldn't use that word "onerous" because I think it really depends on the health of the economy. I think it depends on, of course, how aggressive our competitors want to be. And then I think the bigger piece for us is what we execute on gaining price, as we normally do, throughout the year. So I'm not being negative, but I wouldn't use the word "onerous." But if you look historically at our gross margins, we have ran in that range. And the winter, as I said earlier for sure, we could definitely tick towards the lower end just because of pressure on less demand, more severe weather, which happened about 2 years ago or 3 years ago now. Yes, so we're going to stay focused on driving price, driving proper buying practices as we always do. And of course, I think most importantly, providing great value to the customer base, right, so we are the logical choice. Therefore, price becomes less of a discussion.

[Sam Darkatsh:]

So should we assume then that first half...

[Paul M. Isabella:]

The other piece, Sam, that I would kind of add to the discussion, as you know, one of the biggest drivers of our gross margin is always mix as well too because of the big shift between Residential and Commercial, right? So that's another big driver, which could have an impact.

[Sam Darkatsh:]

So should we figure then that the first half -- first fiscal half, your gross margins might be at the lower end of the range and then your expectation is to have pricing firm by the back half so gross margins will be closer to the higher end in the back half would be the plan?

[Paul M. Isabella:]

Yes, I don't think that that's unreasonable. If you look back 4 or 3, 4, 5 years, '12 was somewhat of an anomaly as you go through the quarterly splits. So 24, close to 24, 25, 25 that was an anomaly. But in '11 we did 23.4, 22 in that winter quarter. So it isn't unusual for us to have those fluctuations of lower 23s, higher 22s during the -- especially if winter starts early in our Q1, and then if it's harsh as we go through Q2. That's somewhat of our pattern.

[Operator:]

[Operator Instructions] We'll take our next question from Kathryn Thompson with Thompson Research Group.

[Kathryn I. Thompson:]

Two questions for you. The first, revisiting the guidance that you gave, first, if you clarify interest expense guidance for the full year fiscal '14. And then also you had noted that -- you've given the lower end of the current analyst EPS range. And there's quite a wide range currently. There's a group being around $1.80 but there's also another at around $1.70, and that's a pretty big delta. Were you referencing be $1.80 or the $1.70?

[Paul M. Isabella:]

Yes, I was referencing that lower end of -- at $1.70.

[Kathryn I. Thompson:]

Okay. And interest expense for the year?

[Joseph M. Nowicki:]

Sure. That gets a pretty granular piece of the detail, that we don't usually kind of forecast out that way. But if you look at one of the big factors to it, the amount of our debt, which we've done a great job of continuing to kind of lower that debt level and that helped us this year. Absent of any acquisitions, that's always a difficult one to put in play here, but without any acquisitions, obviously, you can see us continue to work down that debt structure so the interest expense will continue to go down next year versus the current year.

[Kathryn I. Thompson:]

[indiscernible] IKO has been making plans to open a new plant in Alabama. Our checks are showing more that it more than likely won't happen in early 2014 but possibly in the latter part of the year. What is the potential impact of that new plant from your perspective, not only in a market where it's opening in the Southeast, but also in the markets where it's currently shipping, so in the Midwest and the Mid-Atlantic? And what's the potential ripple effect there? Or is there not much effect at all?

[Paul M. Isabella:]

Good question Kathryn. I think it's a tough question to predict what that IKO opening will do. We already have enough shingle players that can certainly take care of every market in this country, whether it be GAF, Owens Corning, CertainTeed, PABCO, Atlas. IKO already ships to a lot of locations in the U.S. The Southeast is certainly a good region for them to open up to. So I think it will just be -- we'll have to wait and see if there's going to be pricing pressure. But there's pricing pressure now that's occurred anyway without them. I wouldn't think my opinion right now that there would be a huge impact, which is already happening in the Southeast, where it always has been for a number of years very competitive. So I just think it's going to be another opportunity for the contractors to have a choice in a shingle line as they do across the rest of the country, even in the West, where we sell -- the distribution sells more Malarkey and more PABCO.

[Operator:]

And we'll take our next question from Brent Rakers with Wunderlich Securities.

[Brent D. Rakers:]

First, I was hoping to have a quick clarification. I think you guys said the July month organic was up 14.3% Was that supposed to be 4.3%.

[Paul M. Isabella:]

July -- which month, Brent?

[Joseph M. Nowicki:]

That was this quarter.

[Brent D. Rakers:]

Did you give a July month organic sales number?

[Paul M. Isabella:]

In the script? Yes, I could have given the split, yes.

[Brent D. Rakers:]

Okay, maybe as you're looking for that, I'll just move forward as well. I think in the past, you have talked about both the October and November months in terms of revenues. So I was hoping you could give even a flavor -- I know November is not done -- but a flavor of the trend in November. And then I think in the past also, you've given an idea of what the gross margin trend was at the first part of the December quarter as well. I was hoping if you could maybe provide some insight there as well.

[Paul M. Isabella:]

Yes. I think it was Sam who asked about the -- or Ryan, maybe who asked what GM through the quarter would look like. It's still at that same flattish level that we saw in Q4. November at this point is trending not quite as good as October. I guess, I'll just leave it at that because we're obviously not finished with the month, and I don't want to get too granular on inter-quarter type of numbers. The number I recited in my piece for July was 14.3%.

[Brent D. Rakers:]

Okay. I'll address that, I guess, offline. And then just, I guess, a follow-up question, you've had a lot of talk about gross margins and, I guess, the moving challenges of some of the price deflation and some of the COGS increasing as well. In the event that you had typical pass-through effects within distribution from the manufacturers side in the quarter, do you have kind of a sense of where that gross margin would have been under that type of environment in the quarter?

[Paul M. Isabella:]

Again, are you -- say it again, Brent, are you talking about the pass-through to our end market?

[Brent D. Rakers:]

Yes, if distribution pricing was able to pass through the supply price increase cleanly as they typically do, what would of the gross margins been in the quarter?

[Paul M. Isabella:]

Well, I mean, we ended up at negative 0.5 point. As we started -- well before the beginning of the quarter, we had expected and hoped to see 2 to 3 points of price -- positive price in the quarter. I mean, I didn't have any illusions that we'd see 5 or 6 in the quarter. But 2 or 3 to us at that time seemed reasonable.

[Operator:]

We will take our next question from Michael Rehaut with JPMorgan.

[Jason Aaron Marcus:]

This is actually Jason Marcus in for Mike. The first question is, hoping you could talk a little bit more about your acquisition pipeline, and I think you made almost $300 million of acquisitions in calendar 2012. But we haven't seen any major announcements yet this year, so I was hoping maybe you could comment on what you're seeing on the acquisition, front, kind of what the current multiple you're seeing in the marketplace and how we should think about acquisitions going into 2014.

[Paul M. Isabella:]

Yes, we obviously -- in the calendar year, we did very, very well. And towards the end in our fiscal year, we did very well, as I talked about, with McClure-Johnston and Ford and CMS. And I think what we're seeing now is no different than what we've seen in past years, where we have very robust years of acquisitions. And then there's a lull, and that's just a function of the fact that these independent distributors have really their own timeframe. And we're certainly not going to necessarily induce it any quicker via price because we're prudent on that front. And I'm not concerned at all. So the activity level is the same as it was 1.5 years ago before we did started to do the bigger pieces of a deal with Cassady Pierce and Structural prior to that Fowler & Peth. And at that time there had been a little bit of a lull just because of the recession, et cetera. So I think we're in the same point we've been at any period, where there's a little bit of a lull, and that's a function of these very solid distributors getting ready to pass the torch in terms of their transition plans. So I would expect, as we said 18 months ago, 20 months ago, that we're going to see at some point in the future the same elements at work that will have folks selling, whether it's us buying them or our competitors buying them. I think it's -- we'll see that continue. That's not going to change. And then from a multiple standpoint, we don't talk about it. We value these companies based on the power of their earnings and their strategic fit. And I think that's the appropriate way for us to look at it. And we pay what we believe we can bear on our balance sheet and in the P&L going forward knowing that there's going to be synergies.

[Operator:]

And this concludes the question-and-answer session. Now I would like to turn the call back over to Mr. Isabella for his closing comments.

[Paul M. Isabella:]

Great. Thanks. Let me go over a few highlights of today's call. Sales were a record $684 million for the quarter, with strong organic growth of 6%. Adjusted EPS, as we said, for the quarter ended at $0.56 versus $0.60 last year, and for the year, that adjusted EPS was $1.45 versus $1.67. Cash flow was strong at $76 million, as I said. And our growth strategy continues to be executed on the greenfield piece as we opened up 7 in the quarter, 10 for the full year, and we plan to open up 15 to 20 in 2014. We started out October very strong, and we're pleased with sales growing 18.3% in total and 11% organically. And as I just said, the acquisition pipeline is still full. We're confident in the future. We'll be able to make additional investments. We have not stopped working on this important piece of our strategy. As I said on previous calls, our business model has not changed, the market and market dynamics have not changed. We're very focused on being the best service provider to our customer base. We're focused on growing profitably, and we'll continue to focus on cost control and gross margin growth. Our market is large and growing and serves mostly replacement business. New construction is also growing, and we are participating in this. Key for us is to continue executing our strategic plan and provide compelling shareholder and customer value, and we know we'll do this. As always, I'd like to thank the employees of Beacon, and the support of our investor base. We'll continue to work on executing both our short-term and long-term plans. Thank you for the -- your interest in our company. Joe and I are available here in Herndon for any other questions you might have. Have a safe and happy holiday. Thank you, and this concludes the call.

[Operator:]

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