Beacon Roofing Supply, Inc.

Good afternoon, ladies and gentlemen, and welcome to the Beacon Third Quarter 2021 Earnings Conference Call. My name is Nye, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be conducting a question and answer session toward the end of this conference. At that time, I will give you instructions on how to ask a question. If at any time during the call you require assistance, please press star followed by zero, and a coordinator will be happy to assist you. As a reminder, this conference call is being recorded for replay purposes. This call will contain forward-looking statements, including statements about the company's plans and objectives and future economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historic or current facts and often use words such as anticipate, estimate, expect, believe, will likely result, outlook, project, and other words and expressions of similar meaning. 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 factors 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, August 5, 2021, and accept as required by law. The company undertakes no obligation 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. I would now like to turn the call over to Mr. Bernice Songvi, Head of Investor Relations. Please proceed, Mr. Songvi.

Thank you, Nai. Good afternoon and welcome to our fiscal third quarter 2021 earnings call. With me on the call today are Julian Francis, President and CEO, and Frank Lanegro, Chief Financial Officer. Our prepared remarks will correspond with the slide deck posted to the investor relations section of Beacon's website. After management's prepared remarks, there will be a question and answer session. I will now turn the call over to Julian. Thanks, Bennett.

Our fiscal third quarter results are outstanding. Our team delivered record quarterly sales, net income, and adjusted EBITDA. Sales increased approximately 21% as revenue grew across all three product categories. Adjusted EBITDA was more than 75% higher on significant gross margin expansion and operating cost leverage, and we delivered 12.3% adjusted EBITDA margin for the quarter. We continue to be thrilled with our team's execution. Beacon's performance is a result of every employee's hard work serving customers and living our values. I will begin on page four of the slide materials and discuss the key highlights from our third quarter continuing results. Demand trends remain strong. Residential roofing sales increased 18% compared to the third quarter last year. New construction demand continued to be strong. The positive housing market fundamentals also provided a tailwind for our team to drive complementary product sales up 35%. In addition, we grew non-residential sales by 16% compared to the COVID impacted prior year period. Our price execution across all product categories delivered strong gross margin improvement, a critical focus area for us over the last 12 months. We continue to see inflationary pressure across most product categories. In this environment, it's critically important to stay ahead of the cost curve. With cost increases across a number of product categories 60 days apart, even slight delays in implementation can quickly erode profitability. So our focus has been on driving great execution at the branch level. Third quarter gross margins expanded to 27.6%. We expect to see cost pressure to continue, but are confident that we can execute to capture additional pricing to offset the headwinds. Our actions in fiscal 21 have positioned us for growth. These include creating significant financial flexibility, assembling a new executive leadership team, optimizing our inventory levels, and investing in new capacity to meet the anticipated growth. Let me touch briefly on each of these. As detailed on our Q2 call, we restored financial flexibility through a combination of debt pay down and a series of refinancing transactions finalized in May. The results are a stronger balance sheet, lower cash interest and net debt leverage of 2.4 times at the end of the quarter, less than half what it was a year ago. We now have ample ability to invest in value-creating growth opportunities going forward. As a leading distributor of exterior products, we are trusted by our customers to reliably deliver high-caliber service in any demand environment. We have proactively invested in inventory to ensure we are able to meet anticipated demand as we see it develop in local markets. Our backlog metrics are strong and continue to grow. For example, open orders, a key metric of future demand, is up significantly both year over year and sequentially at the end of the third quarter. Our growth and transformation story has allowed us to attract highly talented C-suite leaders, bringing the team new capabilities in human resources, legal, marketing, and supply chain that position us for the future. These individuals bring great talents to BEACON that are essential for our desire to innovate, deliver growth, improve operational performance, and drive value for stakeholders. As part of our positioning for growth, we have commenced investment in greenfield capacity, including two locations open so far in fiscal 21 and one additional location to be added before calendar year end. These new locations not only enable us to meet additional demand, but also allow us to further optimize our branch network and deliver more value to our customers. We will also deploy resources and our financial strength to add M&A to our growth toolbox. We have recently reactivated the process of reviewing acquisition opportunities. Our pipeline of potential targets is growing, and we are actively evaluating tuck-ins that are actionable, a good fit, and available at the right place. We will be disciplined in our approach to inorganic opportunities. The final item I'd like to highlight from our third quarter is the progress we've made related to our diversity, equity, and inclusion goals. Of particular note is that we announced the winner of the first annual Female Roofing Professional of the Year Award to Stephanie Paris. Stephanie leads Brahma Roofing and Construction based in Windsor, Colorado, and is a powerful advocate for women and a role model to anyone who wishes to inspire young people. It is individuals like her and all our nominees that inspire the most skilled and talented people to join our industry. Let me summarize by saying that the confidence we have in our growth plan is underpinned by our team's demonstrated ability to react to a rapidly changing environment and to execute at a very high level simultaneously across multiple critical initiatives. Now please turn to page five of the slide deck. As we have done in prior quarters, let me provide an update on our four strategic initiatives. These initiatives remain central to our improved sales growth, operational efficiency, and profitability. Our approach is systematic, our plans measurable, and progress tangible. Most importantly, our customers benefit from these initiatives as they are designed to make us more efficient and easier to do business with, as well as differentiate us from our competitors. Let me begin with organic growth. As we've discussed on previous calls, our sales and operations team have thousands of interactions with our customers on a daily basis. Our plan has clearly defined initiatives focused on improving both the number and the effectiveness of these interactions. We continue to invest in developing our sales team and providing value-added tools that improve their ability to manage customer relationships. One example is our investment in pricing capabilities. We have implemented tools and training to support enhanced pricing execution at the local level. Advanced analytics are allowing our team to develop value-based pricing models that are responsive to local market conditions and allow Beacon and our customers to realize value from the partnership. Next is our industry-leading digital platform. Digital is a clear differentiator for Beacon. Our adoption rates continue to rise, and we have nearly 50% more active users of our online platform in the third quarter compared to last year. Digital sales are trending around 14% of net sales in our fiscal third quarter and continue to grow. We are expanding our digital offering in value-added ways. In recent months, we announced a partnership with Estimating Edge, a provider of detailed construction measurement and project management software for our non-residential customers. and we've recently integrated EagleView, a roof estimation tool, into our ProPlus platform. This gives customers access to high-resolution aerial images for measurement, which saves them time and money while minimizing the need to access the roof directly, supporting safety for their employees and convenience for the homeowner. Next, moving on to our on-time and complete network. Our OTC strategy leverages the density of our branch network in larger MSAs. We operate in 58 distinct markets and have more than 250 branches participating in OTCs. 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. In this supply-constrained environment, we've leveraged our OTC network to ensure product availability issues are minimized for our customers. The second benefit is a lower cost to serve. Since we optimize across a network of branches, we reduce delivery time and mileage, improving labor efficiency and reducing fleet costs and emissions. I'm pleased to report that we have reduced hours per delivery by more than 4% and reduced fuel per delivery by nearly 3% in the trailing 12 months. The third benefit is inventory levels. We've previously indicated we can permanently reduce our inventory by 50 to 100 million as we implement our OTC initiatives and remain confident that we can hit that target. One example is our state-of-the-art Houston hub expected to open later this year. It has been designed from the ground up for speed and efficiency for our customers. And its prime location, large warehouse capacity, and centralized dispatch center allows us to optimize our inventory position across the fifth largest MSA in the country. And the fourth benefit is that we can accelerate our talent development. Our OTC creates opportunities for our people to explore a variety of roles in the field. This way, we have better retention and development of talent in our logistics and field operations. Finally, I want to update our branch performance operating targets. I've talked extensively about our focus on the bottom quintile branches and our goal to significantly improve their operating performance. We've developed a diagnostic tool and a reporting cadence that places emphasis on structural change to ensure that improvements are sustainable. We continue to accelerate our progress and now expect at least $40 million year-on-year improvement from the lowest quintile branches in fiscal 2021, up from the previous guide of $30 million. We will continue to focus on driving sales and operating improvement to bring these branches over time up to at least our company average. In summary, our strategic initiatives continue to gain momentum and are delivering measurable results. Our new leadership team is energized and focused on accelerating our growth and profitability, creating meaningful improvement in shareholder returns. Now I'll pass the call over to Frank to provide deeper focus on our third quarter continuing results. Thanks, Julian, and good evening, everyone. Turning to slide seven, we achieved nearly $1.9 billion in total net sales in the third quarter, driven by strong sales and price execution across all three product categories. Roughly half of our 21% growth came from volumes, as demand for our products continued to benefit from residential tailwinds, as well as significant growth in our non-residential and markets. Residential roofing sales were up over 18%. on robust demand from our new construction customers. Our largest national home builders were up more than 40% as the housing fundamentals continue to drive new housing starts. We also saw regional strength in repair and remodeling as homeowners continue to take advantage of rising home equity values, low interest rates, and a number of secular trends, namely work from home, millennial household formation, and de-urbanization. The April and June shingle price increases also contributed to the residential revenue growth. Major storm-related activity was down year over year, impacting our volumes mainly in the Midwestern states. We estimate that our residential shingle volumes were down approximately 10 percentage points during the third quarter due to lower wind and hailstorm activity as compared to the prior year. Non-residential roofing sales were up more than 16%. compared against the COVID shutdown trough in the year-ago period. We remain optimistic that non-residential activity will continue to improve. Complementary product sales increased 35% in the third quarter. Keep in mind that our complementary product category has approximately 80% residential and 20% non-residential exposure. Complementary benefits from the residential market tailwinds, including demand for key products such as siding, lumber, windows, and doors. Siding sales, for example, were up more than 30% in the third quarter, and lumber had substantial price growth year over year. Turning to slide eight, we'll review gross margins. Gross margin improved to 27.6%, or 380 basis points year over year. The supply-demand environment remained conducive to the team's successful implementation of two price increases in the third quarter. Similar to the prior price increases, we quickly and thoroughly implemented our April and June shingle price increases. The execution of both price increases created favorable timing benefits, which also contributed to gross margin expansion during the quarter. In addition, our private label sales increased approximately 30% year-over-year, providing gross margin enhancement. As a result, price cost was positive by approximately 390 basis points in Q3. By comparison, we experienced 230 basis points of year-over-year price cost benefit in Q2. Product mix was slightly unfavorable in the quarter due to the significant growth in the non-residential and complementary product categories. Now shifting to our operating costs, under Julian's leadership, we continue to see measurable progress in operating efficiency and remain focused at both the corporate and local level. We are leveraging many of the changes we implemented in response to COVID and are capitalizing on the opportunity to apply those principles in a stronger demand environment. Our third quarter results demonstrated our focus on managing expenses in times of growth. Adjusted OPEX was $309 million, a $52 million increase compared to the year-ago quarter, mainly due to volume-related expenses and higher incentive compensation. We are proud of this performance given the unusually low comparable in the prior year. You may recall that we took significant and proactive cost reduction measures, including furloughs, salary cuts, reduced work weeks, the near elimination of overtime travel and entertainment, as well as reducing the truck fleet to curb fuel and repair costs. We continued to ramp headcount sequentially in the third quarter to meet the seasonal peak in activity. It is worth noting that headcount was up less than 6% compared to an increase in volumes of approximately 10%. Our Q3 adjusted OPEX to sales percentage improved by 10 basis points year over year as our team members managed both our fixed and variable costs with discipline. We continue to focus on the elements of our business that we can control. Improving productivity within our largest cost centers, including labor and fleet, is a major focus for Beacon. As you can see, we generated nearly 50% improvement in sales per hour work compared to the start of the pandemic and are even more productive than the third quarter of last year. This key productivity metric demonstrates that we are becoming more agile as an organization and our productivity initiatives are continuing to deliver value. Going forward, we will continue to implement improvements throughout our organization as we fully embrace a continuous improvement mindset. Turning to slide nine, we will review our financial flexibility. As we discussed on our second quarter call, the divestiture of the interiors business yielded after-tax net proceeds of approximately $750 million. These funds, plus balance sheet cash and cash flow, have allowed us to reduce gross debt by approximately $1.7 billion year over year, consistent with our commitment to restore financial flexibility to our company. During the third quarter alone, we reduced gross debt by $460 million as compared to the end of the second quarter. As a result, we lowered net debt leverage to 2.4 times trailing adjusted EBITDA as of June 30th. Well below our three times target and ahead of our expectations. What a difference a year makes. In addition, a comprehensive refinancing during the third quarter significantly eliminated refinancing risk as we have no meaningful debt due until 2026. At current debt levels and interest rates, you can expect go forward cash interest to be $50 million lower than the trailing 12 months. importantly our strong liquidity position of more than 1.4 billion dollars as of june 30th provides ample ability to invest in the growth of our core business as julian mentioned we will be deploying capital to accelerate our growth this includes investing in our inventory to ensure we can effectively and efficiently meet future demand in an inflationary environment with supply chain volatility as you can see our third quarter inventory is typically our peak level and positions us to meet the seasonal demands of our customers. This year is no different. If you account for the impact of recent manufacturer price increases, our inventory balance is right in line with the 2018 and 2019 non-COVID comparables. Adjusted operating cash flow is $125 million in the quarter, reflective of strong earnings and higher inventory levels. One housekeeping item, gap operating cash flows were adjusted in this view to account for items related to the sale of our interiors business. We've included the reconciliation table in the appendix in this presentation so you can tie this out. We believe the adjusted view provides the best view of the operating cash flows of our continuing operations. In the coming quarters, we will be looking to use our financial flexibility to invest in both organic growth through the addition of green fields and inorganic growth by starting to execute on our growing pipeline of tuck-in targets. To wrap up, we're very pleased with the performance in the quarter. We are well positioned to finish our fiscal year strong, and we are poised for growth in the coming quarters. With that, I'll turn the call back to Julian for his closing remarks. Thanks, Frank. Before we turn the call over to questions and answers, I want to update our fourth quarter outlook. Please reference page 11 of the slide materials. As we look to the fourth quarter, demand remains solid. For our fiscal fourth quarter ending in September, we expect total sales growth in the mid single-digit range. Keep in mind that this guidance is within the context of an extremely strong fiscal fourth quarter in 2020 that also benefited from a snapback in demand caused by the severe COVID-related shutdowns. It's also worth noting we expect storm demand this quarter to be meaningfully below the prior year quarter that included the impact of windstorms and hurricane-related demand. Last week, we announced an early September price increase that we expect to implement with the same rigor as our prior increases. Our fourth quarter margins will reflect the positive contribution from the announced increases over the last three quarters. As a result, we expect a meaningful year-to-year gross margin increase of approximately 180 basis points to around 26.9%. We expect fourth quarter adjusted EBITDA to be between $190 million and $205 million, bringing the fiscal 2021 full-year adjusted EBITDA to between $635 million and $650 million. This is a substantial increase from the outlook we provided on our Q3 call and, for the full year, represents more than 60% improvement over fiscal 2020. While uncertainties continue to exist, including the ongoing threat of COVID, this outlook reflects our expectations for a combination of higher sales, gross margin expansion, and continued cost discipline. Looking further out, we continue to have strong fundamentals in both new construction and the replacement market. In new home construction, the well-documented underbuilding of the last decade has created an undersupply of housing in the millions of units. Our home building customers continue to try to meet this demand while managing the impact of lot, labor, and material constraints. These constraints have led to elongated construction cycle times that appear to have limited impact on the demand side. Residential roofing demand will also continue to benefit from the multi-year repair and replacement cycle from housing stock built more than 20 years ago. Bear in mind that more than 90% of re-roofing demand is non-discretionary. Both our residential and complementary products business will benefit from these trends. Regarding non-residential demand, commercial builder sentiment continues to improve. This is a positive trend that we have seen since our fiscal first quarter, and we would expect it to continue as it gradually benefits from the macros. The architectural billing index is a good proxy for future mid-demand, and it has been climbing. As we look forward to the coming quarters, we have confidence in our team's ability to execute at a very high level. We are poised for continued growth, and I thank our more than 6,000 team members for their effort. I am excited about our progress towards achieving our full potential and believe we are strategically and financially positioned for growth as we help our customers build more. With that knife, we are now ready to open the line for questions.