Beacon Roofing Supply, Inc.

Good afternoon, ladies and gentlemen, and welcome to the Beacon First Quarter 2021 Earnings Call. My name is Kathy and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be conducting a question and answer session towards the end of the conference. At this time, I will give you instructions on how to ask a question. If at any time during the call you require any further assistance, please press star zero. and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. This call will contain forward-looking statements, including statements about its plans and objectives and future economic performance. Forward-looking statements are only predictions and are subject to a number of risks and uncertainties. Therefore, 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 factor section of the company's latest Form 10-K. These forward-looking statements 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. The forward-looking statements contained in this call are based on information as of today, February 8, 2021, and except as required by law, the company undertakes no obligations to update or revise any of the 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. The company has posted a summary financial slide presentation on the investor section of its website under events and presentations that will be referenced during management review of the financial results. On the call today for a beacon will be Mr. Julian Francis, President and CEO, and Frank Lanegro, Executive Vice President and CFO. I would now like to turn the call over to Julian, Mr. Julian Francis, President and CEO. Please proceed, Mr. Francis.

Thank you, Cathy. And good evening and welcome to our first quarter fiscal 2021 earnings call. On the call with me, as Cathy said, is Franklin Agro, our Chief Financial Officer. Our prepared remarks will correspond with the slide deck, which is posted to the investor relations section for Beacon's website. Before I get into the details, as you know, we have announced the divestiture of our interiors business. As such, we are providing two sets of financial information in today's earnings release. The primary focus will be on our continuing operations, which focuses solely on the exteriors business and treats interiors as discontinued operations. I know many of your models are still based on the combined company, so we've also provided summary information on the combined results. I hope the additional information will help you better gauge our first quarter performance and support your analysis going forward. On a continuing basis, we generated Q1 sales of $1.6 billion, an 11.4% year-on-year increase. Adjusted EBITDA improved to $143 million from $77 million the prior year. On a combined basis, so including interiors, Sales were $1.8 billion with 9% sales growth. Adjusted EBITDA for the combined business was $158 million compared to $94 million in fiscal Q1 last year. We believe both sets of numbers are important in understanding our first quarter results, but our remaining commentary this evening will focus on the continuing exteriors business. Within the appendix of our slide presentation, we've included supplemental 2019 and 2020 income statements for the continuing exteriors business that should help you in modeling our reform of financials. I'll now begin on page four of the slide materials, which focuses on our first quarter continuing results. Our fiscal 2021 is off to a great start. First quarter continuing adjusted EBITDA increased 86% driven by the strongest quarterly organic sales growth in more than four years and one of the best first quarter EBITDA margin percentages in over a decade. We have strong leadership and are very proud of the team's execution the past three or four quarters. I believe that this quarter gives you a sense of what the company is capable of delivering. Now there are several important takeaways from the first quarter. First, But residential demand is strong. Residential roofing sales increased 21% in the quarter. Strong reroofing and new construction activity was aided by milder weather, which opened up additional work days for our customers. In a few Gulf states, demand was boosted by hurricane-related repair work. And the strong demand environment provided a favorable backdrop for the successful price increase we implemented in August. The positive housing market fundamentals also helps boost exterior complementary products. With the divestiture of interiors, our product mix is now more residentially focused and biased towards repair and replacement activity. Second, we continue to demonstrate good execution on our price actions. As highlighted during our last quarterly call, our team moved quickly in response to the August shingle price announcement from the manufacturers. We implemented higher prices to essentially coincide with the timing of the supplier increases. And as we have discussed previously, the timing and execution of our price initiatives created favorable timing benefits, which positively contributed to gross margins in Q4-20 and continued in the first quarter of fiscal 21. First quarter gross margins were 25.4% for continuing operations, exceeding our expectations. We continue to see inflationary pressures across most product categories, and we are confident in the current environment we can capture additional pricing opportunities to more than offset the cost headwinds. Third, first quarter results demonstrate our ability to manage operating costs. One of our central goals as a leadership team is to aggressively manage costs in all demand environments. We are extremely proud of our expense management during the past three COVID-impacted quarters But we recognize that with all the moving parts during COVID and the year-end close, determining the impact of our actions has been difficult. We see the first quarter as an indication of the progress we've made. During Q1, continuing adjusted OpEx dollars declined 3% year on year, despite an 11% sales increase and a higher than normal residential mix, which is typically higher cost to serve. In a growth environment, An important part of our focus is to generate significant operating leverage. Closely watching costs and managing the controllable aspects are day-to-day considerations as we run the business. Now please turn to page five of our slide materials. In our previous outlook commentary, we have taken a more cautious view on quarterly results, reflecting the potential impact of weather disruptions. However, our November and December monthly sales growth accelerated meaningfully. a reflection of strong underlying demand and favorable weather conditions. Our continuing business finished with strong 11.4% sales growth for the quarter. Gross margins at 25.4% were stronger than anticipated with the upside from favorable residential mix, supplier incentives tied to higher volumes, and continued price execution. Our first quarter operating expense outlook centered on cost management tied to anticipated winterization during the quarter. As noted earlier, we're very pleased to report a meaningful OPEX decline, even with robust sales growth. Frank will share some of our specific productivity measures later. For the continuing business, adjusted EBITDA increased from $77 million to $143 million, and EBITDA margins increased from 5.4% to 9.1%. The favorable performance was driven by a combination of strong sales growth, a significant year-to-year increase in gross margin, and a reduction in operating costs resulting in significant OPEX leverage. Moving to page six of our slide materials, let me provide you an update of our planned interiors at Bastichette and a view of our business following the transaction's close. We announced in late December the sale of our interiors business to American Securities. will subsequently integrate the transaction with their recently completed acquisition of foundation building materials. We're making great progress and expect the deal will close later this week. The interiors business includes more than 80 branches focused on wall board, ceiling tile and grid, steel studs, and insulation products. Interiors operates from a separate branch network from our exterior locations, making for a clean separation of the business. We were pleased with the outcome of the process that secured an attractive valuation of $850 million for the interiors business. Importantly, the proceeds allow us to improve our balance sheet, immediately lower our net debt leverage to very near our previously published targets, and provide us with much greater financial flexibility. The divestment will return Beacon to its legacy position as a focused leader within exterior building products distribution. 80 to 85% of our continuing business will be within residential and commercial roofing. We review the roofing market's attributes as relatively unique. More than 80% of residential and non-residential roofing is classified as repair and replacement, with the majority of that being non-discretionary and driven by the replacement of worn or damaged roofs. The remaining 15% to 20% of our exteriors business is complementary products consisting largely of siding, windows and doors, lumber, and waterproofing products. These exterior complementary products have some overlap with roofing customers and shared distribution facilities providing meaningful sales and operating synergies. To summarize, we feel the interior servastature represents a transformative strategic event for the company. narrowing management's focus, substantially improving our balance sheet and financial flexibility, and concentrating the business around our core capabilities. Next, please turn to page seven of the slide deck. In recent quarters, we've provided updates for each of these four strategic initiatives. In light of the interior's divestiture, we felt it was appropriate to reset our financial targets and metrics for each. These initiatives remain central to our improved sales growth, operational efficiency, and profitability. Some of the impact can be directly measured, but there are also additional benefits which are less obvious but play an important role differentiating us from competitors and adding incremental value from customers. Let me begin with organic growth. This initiative is focused on improving both the number and the effectiveness of interactions between our sales organization and customers. We continue to invest in sales training programs, marketing support, and value-added tools that help our salespeople track their contacts with existing and potential new customers. And we have established targets for our sales team involving the number of interactions daily, and we know that meeting these objectives strongly correlates to driving overall company sales performance. Next is our industry-leading digital platform. Digital is a clear differentiator in the marketplace for Beacons. During our last quarterly call, we disclosed that digital sales had reached a run rate of 10% of total company sales during the final month of fiscal 2020. Our exteriors business was further along the adoption curve than interiors, so we expect to see another bump in adoption this year. We have continued to leverage the customer adoption rates that accelerated during the early COVID environment and are confident our current year and long-term growth trajectory will cement our leadership. Digital is an excellent example of how a sharpened post-investiture focus should pay dividends for growth. Our marketing organization will now be able to devote 100% of their time to the exteriors products on the platform and develop new offerings. Next, moving to our on-time and complete network. Our OTC strategy creates a network of branches in larger MSAs. We operate in 58 distinct markets and have more than 250 exteriors branches participating in OTC. OTC provides four key benefits. First is improved customer service as we have greater flexibility to deliver from the branch with the best combination of product and service to support the customer's needs. Second is a lower cost to serve. Since we can optimize across a network of branches, we get reduced delivery time and mileage, improving labor efficiency, and reducing fleet costs and emissions. Third, reduced inventory levels. We've previously indicated we believe we can permanently reduce our inventory by $50 to $100 million as we optimize across our OTC branches, and we remain confident that we can hit that target. And fourth, we can accelerate our talent development. Our OTC creates opportunities for our people to explore a variety of roles at Deakin and build increasing levels of responsibility, allowing them to build great careers at our company and reach their full potential. Lastly, I want to update our branch operating performance targets. I've talked extensively about our focus on the bottom quintile of branches and our goal to significantly improve the operating performance. We've developed a diagnostic tool and a reporting cadence that places emphasis on structural change to ensure we get sustained improvement. We previously guided to a $30 million to $60 million improvement at these branches that we've achieved over several years. We shared on our prior earnings call, and in fiscal 2020, we've seen a more than 20 million year-over-year improvements, the majority of which came from exteriors branches. With the success we saw during the first year of the program, we are now resetting our 2021 target to a 20 million year-on-year improvement from the lowest quintile exteriors branches. Each year, we will continue to focus on driving sales and operating improvements to bring these branches, over time, up to at least our company average. To summarize, my update on our strategic initiatives, neither the objectives nor their anticipated impacts to BEACON have changed following the Interior's Dev Exit Show. Instead, it has sharpened our focus on these programs, likely enhancing their effectiveness over time. Now I will pass the call over to Frank to provide deeper focus on our first quarter continuing results.

Thanks, Julian, and good evening, everyone. As Julian highlighted, we are providing significant transparency this quarter with first quarter results for both continuing operations, exteriors only, and combined results, exteriors plus interiors. This is designed to assist you as you compare our first quarter results with your current model and as you adjust your go-forward model for our continuing operations. Turning to slide nine, sales within our continuing exteriors business improved 11.4% year-over-year. Sales growth accelerated materially from the previous quarter, and our monthly growth rates accelerated throughout Q1. Residential roofing produced more than 21% sales growth, as housing market indicators remain favorable for new construction and core repair and remodeling. This year, we saw the roofing season extend further into the early winter months, given the strong underlying demand and milder weather in many geographies. Sales also benefited from regional strength in several southern states tied to hurricane-related repairs. Commercial roofing sales declined 3%, reflecting significant improvement from the double-digit decline we experienced in Q4. We believe the combination of milder temperatures and hurricane business were helpful to commercial roofing in the quarter. From a more fundamental perspective, the worst is likely behind us in commercial roofing and the comparison to ease during the second half of fiscal 2021. However, there remains lingering uncertainty for new construction and re-roofing within the office and retail markets. We continue to adopt a cautious commercial outlook until we see tangible evidence that demand deferred from 2020 will occur this year and building owners return to more normal timetables for capital projects. Complementary product sales increased nearly 9% in the first quarter. Remember that this growth rate reflects only our complementary exteriors business. which has a higher residential and market exposure. As you think about the mix of complementary going forward, we view this as being approximately 80% residential and 20% commercial. Key complementary products for residential include vinyl siding, fiber cement siding, lumber, windows, and exterior doors, while our complementary business for commercial is primarily waterproofing. Both categories are distributed through our traditional branches and share overlapping customers with that roofing business. Turning to slide 10, we'll review gross margins. Gross margin for continuing operations was 25.4%, increasing 140 basis points year-over-year and 30 basis points sequentially. The drivers of the strong year-over-year increase were equally split between favorable price cost and favorable mix. On a year-over-year basis, price cost for continuing operations was positive by approximately 70 basis points in Q1. By comparison, we experienced 90 basis points of year-over-year price cost benefit in Q4. In the first quarter, price cost was favorably impacted by our successful implementation of recent pricing increases, the remaining timing benefit related to the August increase, and higher incentives based on stronger sales. We also benefited significantly from favorable product mix in the quarter as we experienced stronger residential roofing sales. To sum up, first quarter gross margins were above our expectations, driven largely by the combination of sustained successful pricing execution and factors linked to our strong residential sales, including product mix and higher incentives. And as you know, there have been additional pricing increases announced across a broad range of our products, We are approaching those increases with the same level of rigor and execution we have demonstrated in recent periods. Now shifting to operating costs, to add on to Julian's earlier comments, we've made some tremendous strides in this area, particularly the past three quarters. In my opinion, our first quarter performance is a meaningful demonstration of what Beacon is capable of delivering. While third quarter 2020 highlighted our ability to make temporary cost reductions in a period of challenging demand, the first quarter shows our focus on managing expenses in times of significant growth. Adjusted OpEx for continuing operations was $276 million, a $9 million reduction from the year-ago quarter. Despite sales growth of more than 11%, we were able to generate a 3% reduction in adjusted operating costs. An accomplishment our entire organization is very proud of. and is testament to the dedication of our field leadership and of thousands of Beacon employees delivering for our customers every day. We continue to focus on the elements of our business that we can control, and improving productivity within our largest cost centers, including labor and fleet, are a major focus for Beacon. We have updated the headcount and sales per hour work data to reflect current and historical data specific to the exteriors business. As you can see, Even with the significant uptick in demand over the past several quarters, we finished Q1 with headcount down more than 5% year-over-year. Our reduced headcount combined with 11% top-line growth generated a significant increase in sales per hour work, which is up 25% compared to last year, and improved sequentially even with the typical challenges of seasonality. In terms of other operating costs, we continue to benefit from reduced travel and entertainment spending, which remains well below historic levels. We would expect a portion of these expenses to come back in over time, but are unlikely to return to historic levels as we continue to leverage greater sales effectiveness and operating efficiencies. As we go forward, we will continue to implement improvements within our business as we fully embrace the continuous improvement mindset. Turning to slide 11, we'll review our cash flow and balance sheet. Importantly, I hope to accomplish three things with this balance sheet and cash flow overview. reset cash flow expectations for exteriors, discuss the use of transaction proceeds, and update our pro forma net leverage. During our previous calls, we commented on our expected cash flow performance for the combined company. Importantly, we expect our continuing exteriors business to have similar cash conversion to the combined company. Obviously, there will be unique working capital fluctuations from time to time that may impact this, but we remain comfortable with these expectations. for cash conversion. We plan to deploy the divestiture proceeds, estimated to be $750 million, on a combination of debt reduction and growth investments. Our current thinking is that debt reduction will be concentrated on our ABL and term loan, with the remainder held as cash on our balance sheet, providing us with the flexibility to invest in inventory as we did this quarter, and the ability to selectively invest in organic and inorganic growth prospects. We have been effectively absent on the acquisition front the past few years because of a relatively high leverage. With the upcoming closing of the transaction, pro forma net leverage for the continuing business will decline to 3.2 times EBITDA as of the end of fiscal Q1. Remember that we previously had a standing target of 3 times EBITDA and we're envisioning roughly 3 years to achieve this objective. We're delighted with the expected outcome of the interiors transaction and look forward to the financial flexibility that comes with lower leverage levels. With that, I'll turn the call back to Julian for his closing remarks.