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.

Ladies and gentlemen, if you wish to ask a question, please press star followed by one on your touchtone telephone. If your question has been answered or you wish to withdraw your question, press the star 2 key. Each caller is limited to one question. The first question is from Catherine Thompson with TRG. Please proceed.

Hi, thank you for taking my question today. In terms of the outlook, I know you gave it for your Q4, but thinking beyond that with the gross margin expansion guidance that you give and outlook beyond it, how much of that expansion is from pricing actions from 2020 versus 21? And how much of it is just being able to focus and stick to your knitting now that you're really exteriors focused firm or other factors that we should take into consideration, like in a mix or an easement of some of the headwinds that we've seen from supply chain? Thank you.

Thanks for the question, Catherine. We've been very pleased, obviously, with the overall progress we've made. And I think if you go back two years, we said we thought there was margin compression due to some of the impact of a declining market and pressures from asphalt. I mean, we've seen, obviously, that turn. I mean, we've seen this demand-related inflation come in, and we've shown our ability to execute really strongly in the marketplace to recover those costs increases that we've seen. I think as we go forward, we would anticipate that this repair in our margin is certainly somewhat sustainable. Certainly over a period of time, we would expect things to fluctuate plus or minus depending on timing. But we certainly feel that the value we generate from the services we provide are incredibly powerful for us to realize gross margin for and pricing. in terms of the overall sort of mix as you highlighted i think when you think about being able to stick to our knitting as you said i think that is incredibly valuable for us i also think initiatives that we've put in place including private label are ways for us to continue to expand we talked a little bit about my prepared remarks the investment we've put into pricing I think that's another area where we see opportunity to continue to refine our local market initiatives and capture value in the marketplace. Catherine, the only two things I'd add would be, you know, digital obviously is a you know, a nice play for us. It's got a little bit of margin enhancement there. And then, you know, the work that we're doing on pricing broadly, but also specifically to the underperforming branches has been really helpful this year as well. And it's, you know, those types of things are more structural in nature and not transitory, depending on which way the pricing happens to be going in at any given time.

Thank you very much.

Thank you, Ms. Thompson. The next question is from Mike Dowell with RBC Capital Markets. Please proceed.

Good afternoon. Thanks for taking my question. I wanted to ask around inventory. I know you cited kind of, you know, relative to the COVID-impacted period the year prior. At the same time, you are seeing sequential increases, and I think there's a comment in the release on the slides about investing in inventory, it's been a tough environment to do that in. So I just wanted to ask about kind of how you're thinking about your inventory levels today and where they stand relative to normal. And, you know, if you're at a point where given the, you know, some potential

slow down in volumes given the tough comp and the upcoming quarter you know will you look to continue to rebuild port levels thanks thanks for the question mike um i think in frank's prepared remarks he commented that third quarter inventory tends to be our annual peak obviously in this environment when we've got an allocated situation on some product lines. Our bias has been to ensuring that we've got the product availability to serve our customers. That's been very important. It's been something that we've really focused on, and we think that we've continued to take the opportunity to rebuild and replenish where we can. Certainly on an annual basis, you would expect it to fluctuate with the seasonality of the businesses we're in. But we're also committed as a leadership team to ensure that we're managing it at the right levels on an ongoing basis. I think just in this environment, I would tell you that Certainly my bias and Frank's bias has been to err on the side of having more rather than less inventory, given the current situation, the demand environment, and the supply chain disruptions, quite frankly. I mean, the supply chain disruptions on the non-res side have been pretty substantial, and we act as a little bit of a shock absorber for our customers. And so having a little bit more inventory during that period of time helps us do that and helps us be a better supplier to our customers.

Great. Thanks, Joanne.

Thank you, Mr. Dahl. The next question is from Keaton Mamatora with BMO Capital Markets. Please proceed.

Good afternoon, and congrats on a strong quarter. Maybe, you know, going back to, you know, the branch performance improvement that you've talked about, you are seeing more of that and you are in year two and now you're expecting over 40 million versus the prior estimate. Can you highlight one or two things where you are seeing kind of more opportunity as you work through that? And as you look ahead, kind of talk about what is the further room for improvement on that side? Thank you.

Thank you, Tan. It's Frank. Thanks very much for the question. When we turn the page into 2021, we mentioned that we thought there was a lot of room this year on gross margin and pricing and sales, and that's actually bearing fruit. It's coming through exactly the way that we thought it was going to come through, which obviously creates some operating expense leverage there as well. When we stand back and look at our analytical charts, you know, inside the company and we look at the performance of the underperforming branches relative to the remaining branches, we still see a huge opportunity really across the P&L, whether it's sales, gross margin, or OPEX. There is still a ton of opportunity there. You know, Julian would tell you that in two years we've kind of already hit his initial target, and that just means we're going to raise the bar. You know, we're going to continue to work on this initiative, and we're going to expand it. across the company in other ways. For example, a large branch may be performing but may not be performing at the potential that we think it has. So we're going to run that same diagnostic tool across the company, and we see tons of value still coming.

Thank you.

Thank you, Mr. Mampora. The next question is from Phil Nguyen with Jefferies. Please proceed.

Hey, guys. Congrats on a really good quarter and really trying execution. Frank, I guess your guidance for the fourth quarter for mid-single digit sales growth, that's a noticeable deceleration. Can you talk about, you know, if you saw any pull forward in 3Q, just given the strength you're seeing on res and complimentary, you know, appreciating you got tough comp than res, I would have thought the demand profile might have been a little better. And it would be helpful to kind of parse out how much pricing contributed to 3Q. Thank you.

Sure thing. I think in terms of the Q4 guide, the mid-single digits that you mentioned, it's a strong comp, as one of your peers mentioned a few moments ago. You know, July finished up consistent with the guide that we gave. What I think you're going to see in the quarter, if you want to parse it out, I think the complementary business will be the higher growth, and then non-res and res will be in that kind of low to mid-single digit range. I don't necessarily see pull forward. I see more elongation. I mean, you heard in Julian's remarks talking about project life cycle expansions. You're hearing that from a number of the different home builders. We're seeing it in our business as well. So we don't see this as any question around demand. It's just the ability to get things done. And remember that it's not just shingles as an example that can get in the way of a project completion. It could be cabinets or paint or carpet or anything like that. or it could be fasteners in a particular project instead of the actual membrane itself. So there's a lot happening in those supply chains right now. As Julian mentioned, we're going to err on the side of inventory. The storm hangover that Julian mentioned is real. We saw that. We called it out in the quarter. It would be great if we could have had a strong hail season. We didn't. It would be nice if we get a nice hurricane season as well. So we feel good about the quarter, and we feel good about the multi-year demand run that you heard Julian talk about. In your volume question around the quarter, I think that's an important question, what we said was that the 21% growth, about half was volume and half was price. In the aggregate, if you break it down by line of business, the reggie side was more price than volume, and the non-reg and the complementary side were more volume than price, all positive across the board, just inflections there that I thought you might enjoy having some color on.

Thank you. Really appreciate it.

Thank you, Mr. Nguyen. The next question is from Trey Grooms with Stevens. Please proceed.

Thanks. This is actually Noah Markowsko on for Trey Grooms. So, again, just want to echo congrats on a strong quarter. Very impressive top line, you know, really seeing growth across. all segments, but I wanted to dig a little bit more in the non-res side. You know, we've seen a lot of leading indicators improve, and it sounds like some of that volume is finally starting to come through. So I was wondering if you could break down sort of, you know, if you're seeing more repair and replacement activity or new construction, and then just kind of your thoughts on that and market demand as we go into next year.

Thanks for the question. So to start with, just to frame what we're seeing in the non-residential construction market, and I'll pass it over to Frank. The supply chain disruptions that started early in the year and to some degree were triggered by the weather events that hit Texas back in February when there were a lot of plant shutdowns on the supply chain have been real and they've been continuing. We've had a lot of disruption recently. in terms of project lifecycle. The ability to get one product may be just fine, but the ability to get a full set of products that you can use to complete a job has been much more challenging. And so while we've seen the overall demand improve, The ability to get product onto a job and complete it enough and then restock in a reasonable time has been a real challenge for us. And, again, this goes back to what we said regarding the stocking of inventory and how we act as a little bit of a shock absorber. Trying to assemble a full job packet has been a real challenge. So we've not seen any specific area pick up. The new construction side is clearly improving. I referenced in my remarks the ABI, the Architectural Billing Index, which is what we follow, and that's clearly an indicator of future demand for new construction generally. And that has been improving quite markedly, so I think that's good that we're starting to see bids coming through. um and on the repair and placement side i think we're seeing um perhaps a little bit of growth overall but they're sector specific so i think on government related work schools hospitals and then warehouses we've seen you know continued demand and and that's that's been very positive in some of the retail and office we're seeing a little bit less and a little bit more caution And so we continue to see that, and I think I said that on the last call, where sector-specific markets are improving probably more rapidly than some others. So that's kind of the overall backdrop. I'll let Frank add anything that he feels is necessary. Well, I think you covered it great, Julian. Only maybe data point would be if you look at kind of the year over year by geography, you'd probably see some additional growth in areas that were the hardest hit last year in COVID that are beginning to reopen.

Thanks. That's super helpful, guys. I'll leave it there.

Thank you, Mr. Grooms. The next question is from Truman Patterson with Wolf Research. Please proceed.

Hey, good afternoon, everyone, and thanks for taking my question. Just wanted to understand on your residential sales volumes, it sounds like they were up, you know, mid-high single digits in the quarter. I'm just hoping you can discuss, you know, how much incremental inventory load-in, you know, you all had during the quarter and really trying to balance this with, you know, industry ARMA shipments. Uh, as well, anything, any color you can give us there would be helpful.

Sure. Chairman. Uh, yeah, good, good question on Arma. Um, you know, we're in this allocated environment as I'm sure you all are very familiar with. So, um, we, we bought right in line with Arma as you would expect us to, uh, you know, no one saying no to their allocation these days. Um, you know, they want to make sure like we do, that we all have inventory when our customers need it. We still, still see the strength in demand. We did sell less than armor, which is obviously one of the reasons why we built the inventory. The inventory is really a combination of both units and price, given the manufacturers' cost increases passed through to us. If you look at us on a two-year basis, which I think is an important thing to do, remember that last year, 2020, we monetized inventory pretty significantly, and what you generally monetize are the things that move the quickest. And in our world, that generally is shingles. So if you look at Q320 against Q319, the inventory, again, we were down about 25% in terms of units. If you look at us this year against last year, we're up about 30% in units. But again, you've got to look at it on a bit of a longer-term view to get a good understanding of where we are from an inventory perspective.

Okay. Okay. Yeah, that's exactly what I was trying to parse out there. So it seems like sales out the door kind of in line with the market. That was it. Thank you.

I couldn't tell whether you were making a statement or asking a question, honestly, Truman. But look, I told you we'd You know, we sold less than Arma and we built the inventory. We feel like we're in a really good position given where things are, especially in the inflationary environment. You know, we kind of expected some hailstorms didn't get it. We didn't expect necessarily a late cycle price increase, but now we're delighted to have some inventory to be able to sell it, you know, into the market at a market price at a lower cost. We feel like we're in good shape there.

Thank you, Mr. Patterson. The next question is from Garrett Schmois with Loop Capital. Please proceed.

Great. Thanks for having me on. Just given the balance sheet and the significantly improved cash position, and you spent the last two years delivering and focusing very small-rate operations. You touched on this a little bit. On the M&A side, you're starting to sniff around a little bit more than you have in the recent past. Julian, Frank, if you guys can provide maybe a little bit more of what you're looking at from a high level and what the opportunity set is there.

Thanks for the question, Garrick. Yeah, obviously, we've said we would be absent from the market while we were fixing our balance sheets. And now that we've done that, we feel that we've got the company in a great spot. We're executing at a very high level at the local, at the branch level. The teams really come together. We can now turn our focus back to real opportunities in the marketplace to grow. The way we're framing it is the way we framed our strategy. We're going to continue to focus on the core business. We're going to continue to be incredibly disciplined with shareholders' money, and we're going to look at great opportunities to continue to grow. So it's really about tuck-ins. It's really about local market position and how we can add and strengthen to our position on a local level. That's really where the M&A opportunity lies for us inside of our core business. Obviously, in a market like this where valuations have been elevated, we're going to have to be incredibly disciplined and pick the right markets, pick the right targets where we think we can bring significant value. The work we've done to improve the business over the last several two years is really going to reap benefits as we look at acquisition targets. We understand now what value we can bring. We can bring our digital. We can bring our sales knowledge. We can bring our pricing expertise. We can connect new branches we've acquired into our OTCs. And so we really feel that we've got a great new thesis that we can deploy now in really value-accretive ways through M&A. And obviously, I mean, the big thing here is we fixed the balance sheet. We've got a great business that's performing very well. We're going to generate a ton of cash. And I think that our shareholders want to really ask for us to deploy that in ways that create value for them, and that's how we're coming at it. Got it. Thanks again.

Thank you, Mr. Chemoise. The next question is from Keith Hughes with Truist. Please proceed.

Thank you. I guess the question on residential, you talked about some of the comps in the prior year. If we go back to fiscal fourth quarter 20, what were units up year over year in that period that you're going to be comping against?

Let me ask a clarifying question, Keith. You're saying what was our growth in 2020 over 2019 in our fourth quarter?

Yeah, what was – I mean, I have a – and I don't – you've adjusted some of your numbers. I have a 6% revenue growth for residential products in the fourth quarter, 20 over 19. I don't know what the unit number is. Can you talk about the unit numbers?

Yeah, my recollection is we sold 8 million shingles in the fourth quarter of last year. I'm ballparking you, by the way, which was up pretty significantly. Call it maybe 600,000 units or so on a year-over-year basis. I'm going 20 against 19. Okay. And that's asphalt shingles, which is a component of residential Right. So what do you think about the market as a whole, Keith, last year? I mean, when you look at summer shipments, I think last year were in fiscal fourth quarter 20 were around 44-plus million squares. I mean, I think that was the biggest shipping quarter, and I think there was – The shipments from the manufacturers was pretty much everything they could produce. I think there was also de-levering of their inventory. I think that the channel was also de-levering industry. Demand was so high at this point last year. I think we exited the quarter with pretty much everyone out of inventory. So, I mean, I think the situation was such a strong snapback and the demand was so high. Literally, everything shipped from the manufacturers. I think they shipped all their inventory, and I think that the channel also shipped all its inventory. So it's difficult to repeat that because you can't get the inventory shipments because everyone's been struggling to get an inventory as well. So it's a really difficult comp, but it's also difficult to pass it out into the different elements that I think you're looking for. Your 8% number, if you want clarity on that one, your 8% number that you mentioned is correct against Q420 against Q419 asphalt shingle units. Okay. All right.

That's fine. Thank you.

Thank you, Mr. Hughes. The next question is from Ryan Markell with William Blair. Please proceed.

Hey, guys. Just want to go back to the July commentary. So am I right that residential volumes are negative year over year and that's your guide? And if I have that right, what's driving that? Is it lower storm demand and sounds like there's some elongated projects?

Yeah, I mean, it's essentially What you just said is what we said in terms of putting the guide together for Q4. Okay.

And, you know, I guess what turns the volumes back positive again? Because the compares keep getting harder in the next couple quarters.

Yeah, I think that's fair. I mean, obviously, continuing to see new housing construction stay strong, we believe the demand is there to support that. The supply chain will get back into equilibrium over time. The R&R piece of the equation, I think, will continue to benefit from the housing cycle back in the early 2000s, which I heard Julian mention in his prepared remarks earlier. So I think there's still a lot there, but the comps do get harder, and I do think the pricing environment is going to continue to be conducive for us to pass things through. Is it going to be five price increases in 13 months? Probably not, but we're going to continue to leverage that. So we feel like we're in good shape. When I look at Q4 and you – You look at the home builder commentary and others' commentary, you know, they just talk about the difficulty in getting projects done in as rapid a fashion as they've been used to. That ultimately will solve itself as the supply chains, you know, continue to get back to balance. And, Ryan, I mean, I'll add to this. You know, our business is not asphalt shingles solely. We are a supplier of a lot of different products. And there's multiple. I mean, as we said, it's Storms this year are below kind of a 5, 10-year average, so we would expect to see that to return to normal. We think that as the supply chain disruptions we've seen on the commercial side of the business go away, as that gets repaired, we can see more growth there. In that area of the business, our siding business and our complementary business, as Frank said, has been strong. We continue to see that facing into new residential construction that we see growth for, and we see a long runway of growth in that area. And the other piece of it that we hinted at and have mentioned, I mean, the replacement cycle on roofing is about 20 years. That's give or take. If you go back 20 years and you look at what the builds were, we're entering a really positive cyclical period of strength in the 20-year-old groups. And I think that what we're going to see is that starts to filter into the marketplace. You know, we've got the There's a one and a half, two million starts, single family homes back in the 2001 to 2005 time period. So I think we're going to see continued growth in the repair and replacement market. I just think that we've got a really good cycle going here. We've got underbuilding of new homes. We've got a great replacement cycle. We've got a an easing supply chain challenge on the commercial side. And we've got weather related demand that we think is slightly depressed this year and will return to normal over a period of time. So we're pretty bullish on the future for all of our businesses right now.

Very helpful. I appreciate it. Thanks.

Thank you, Mr. McHale. The next question is from Kevin Hojsevar with North Coast Research. Please proceed.

Hey, good evening, everybody. Quick question on the guidance. In most years, the fiscal fourth quarter is the strongest quarter of the year. And even when it's not, it's pretty close to the third quarter. It implies a pretty large step down in EBITDA from the third quarter to the fourth quarter. So you're in $229 million in the third quarter, guidance of $190 to $205 in the fourth. So I'm I guess that's a bigger step down than we usually see from the June to the September quarter. So I'm curious your thoughts on why that would be the case.

Normal seasonality has to probably look at pre-COVID, not post-COVID, at least for a few quarters for us. But I think if you look at the sales guide that we gave, you're going to see You know, normally you would see weather and geography are quite helpful in July, August, and September relative to April, May, and June. You know, I think the COVID comps from the prior year and the hail differences in Q3 are certainly impacting, you know, that normal one. You know, think about more of a flat to downside. slightly on a quarter-over-quarter basis, you know, with less resume. So you're going to lose a little bit on the top line. The gross margin that Julian, you know, quoted in his guidance would tell you that you're going to lose a little bit on gross margin. You know, we're going to. fight tooth and nail for every dollar we can get on the gross margin line, which hopefully can help us a little bit there. And then on the OPEC side, again, we've got some work to do. We had a hard comp last year in the mid-16s. If you do your math on the guide there, it's in the mid-17s. You know, we're going to continue to look for every dollar there as well. So, you know, something with a two-handle feels pretty good given the environment that we're in, and we're going to continue to scratch for every dollar.

Okay. Thank you very much.

Thank you, Mr horse of our the next question is from David McGregor with long bow research, please proceed.

yeah good afternoon everyone and congratulations on all the progress. I guess, how are you thinking about your free cash flow conversion in the context of your 2021 guidance and just from a I guess from an earnings standpoint, as you think through into 2022. Where's the lowest hanging fruit now in terms of further cost reductions? I mean, you've accomplished so much already, but I'm just trying to get a sense of, from this point forward, how we should be thinking about what are the most accessible opportunities from the standpoint of further cost reductions. Thanks.

So you really asked two different questions in there. Let us tackle both of them. first one on free cash flow and then the other one on cost reductions. The business, as you have seen in the last six or so quarters, has a tremendous ability to generate significant free cash flow. You've heard us talk about a long-term 60% free cash flow conversion of EBITDA. That assumes... a bit of neutrality in networking capital, as you've seen on the inventory build side. It hasn't necessarily been neutral given the environment that we're in. It just delays the realization of some of that free cash flow. We still feel good about that long-term 60% type of a number. It may even be a little bit better given the fact that we've done the refinancing. You heard me mention the lower cash interest costs going forward, so we feel good about that one. But we also have to be attentive to our customers and make sure that we have the inventory that they need in periods of demand. In terms of the OPEX, I'd say it's across the board. The incremental margins that we're generating right now, I think we've thrown up 240s in the last couple of quarters and a 30 this quarter, so we're continuing to leverage the fixed cost and being judicious about adding variable costs in as volumes are there. I think we did a good job of that this quarter, adding less than 6% headcount on 10% volume, so that feels pretty good. I'd say it's more around leveraging what we have and making sure that we minimize the cost of growth. You know, David, we've learned so much about running a company as we've come through COVID and had to face crisis and make tough decisions going through that. We see tremendous benefit from the network of branches that we have and really optimizing them. You know, taking the learning once and deploying 450 times across our network is a huge opportunity for us. So we've focused because we've certainly felt that we have to on the lowest performing quintile of branches that we have. But as Frank hinted to, I mean, we're starting to broaden that perspective. There's no branch we think can't get better. We're looking at all elements of how we can deploy this new learning that we've had. What does a great branch look like going forward? How can we benchmark across our own network and make sure, like I said, we're deploying it once? So we think there's still a lot of runway in terms of operational excellence at the company, and we think that both deploying that through our branches but also leveraging some of the capabilities we have in terms of the otc we don't think we're anywhere near mature on on that approach to how we leverage the marketplace either so we see again a lot of opportunity to continue to to leverage this uh we also want to make sure that uh we We're managing the cost side of it carefully as we do this, and we'll continue to be disciplined in how we do that.

That being the case, it's $40 million a year from the OTC networks and from the, I guess, some of these underperforming branches. You upgraded that number from $30 million to $40 million this quarter. Is that a sustainable rate? Is that how we should be thinking about 2020? 22 is kind of a $40 million rate, or was there something that made this year kind of special, and it might be a little bit less than that going forward?

Yeah, we're going to look at this on an annual basis. We delivered over 20 in 2020, we then kind of restacked the branches based on their performance in 2020, created the new goal, which we thought was going to be about the same as 2020. We've now upped that twice from 20 to 30 and 30 to 40. We're going to continue to push through the finish line and do everything we can. The recipe of success on the underperforming branches is going to be different every year. The population is going to be different every year. I think the important thing is it's an enduring strategy. There will always be a set of branches. which are kind of lower on the totem pole, so to speak, and we believe that we can get more operating profit out of those branches. Again, whether it's going to be a combination of doing more on the sales side, it could be a product mix change, it could be something on the gross margin side, the OPEC side, there's going to be value every year, and it's something that we're going to reset every time we come out with our final year earnings and give you guidance for the following year. We're going to set targets. We're going to manage it just as tightly as we have been that has delivered the value that you've seen so far.

Great. Thank you very much.

Thank you, Mr. McGregor. The next question is from Deepa Rajavan with Wells Fargo. Please proceed.

Hi. Good evening, everyone. Thanks for taking my question. Strong positive price-cost spread here, Julian, but is there a meaningful difference across residential or non-residential businesses? That's one. Are you able to push pricing in non-res as strongly as in res, just given that non-res is witnessing nascent recovery?

Thanks for the question, Deepa. We've seen progress across all of our categories. We've seen price increases across all of our categories as well. But we've certainly executed very well across every single category. It's difficult to quantify it on a case-by-case basis from a product line just because the timing of each of them, the timing that the jobs ship on commercial jobs is a lot different. from when they're priced. So there's a little bit more noise in the commercial side. But I've been incredibly pleased. And I think our execution over the last six months or so has gotten better and better across all of these categories. I think if you look at the positive 390 price cost in the quarter that we mentioned in the prepared remarks, you should view resi as being more favorable than the corporate average on price cost in both the commercial non-res as well as the complementary, while both nicely positive on price cost or just less than the residential and less than the corporate average. But all of that blends together to the 390 that you heard.

Got it. Now that's helpful. How long do you think this inflationary situation continues?

I think you're better off asking the manufacturers than you are us right now on this question, Deepa. I think that the market remains good. Clearly, we are seeing a settling out. And I think that the supply chain disruptions that we've spoken about likely abate over a period of time. So I think that we've had a good run here. And I think that we continue to see opportunities. But we continue to see opportunities to maximize our pricing dynamics across the business without necessarily getting into price increases from the manufacturers either. We think we're building capabilities, we're building models around this. As I said, we're really focused on executing at the branch level, making sure that we get paid for the value we provide, and we remain competitive in the marketplace. We deal every day at a local level with customers coming in who have the ability to make a choice of where they buy the product from. We want to make sure that we are that choice and that we get paid appropriately for the services we provide. We haven't seen the best out of non-residential, clearly. That's still coming back. On the residential side, when you think about the sheer number of homes that are going to be required over the next decade, five to 10 years for all the household formation that's believed to be coming, combined with the underinvestment in that area over the last 10 or 15 years, it gives us a real good feeling for a multi-year play. We look at the home builders and their base price increases year over year. And the new order price is higher than the current closing price, which tells us there's a fundamental support there. You know, as we begin to receive price increases from the manufacturer, that gives us the confidence that we'll be able to pass that through. You know, and the economy is still not clicking on all cylinders. So, you know, we feel like we're not yet out of the, you know, the tougher part of COVID and look forward to the opportunity to run on all cylinders.

That's great, Collette. Thanks very much. Appreciate it.

Thank you, Mr. Raghavan. The next question is from Michael Reholt with JP Morgan. Please proceed.

Hi. This is Maggie on for Mike. Thanks for sneaking me in here. On 3Q growth margins, you pointed to timing benefits and cost-effective procurement as being tailwinds. Can you talk about how long those benefits last?

Well, sure. We mentioned a couple of things in the quarter that were helpful on the price-cost side. We mentioned that there was a little bit of a headwind on mix, just given the differential growth rates and gross margin rates there. When you look at two price increases in a quarter, there were certainly some timing benefits and inventory profits, so to speak. But to me, when you look at Q4, we're guiding to 180 basis points. you know, of gross margin benefit, I think that the price cost will be higher than that and the mix will be somewhat negative. So that'll tell you that we continue to see positivity in price cost in Q4.

Okay, thank you.

Thank you, Maggie. The next question is from David Manthe with RW Baird. Please proceed.

I'll take my questions offline, guys. Thanks.

Thank you, Mr. Manthe. That concludes the questions. Now I would like to turn the call back over to Mr. Francis for closing remarks.

Thank you, Nye. And thank you everyone for joining this evening. We certainly appreciate your support. And really, the last statement I would make is that we hope that the employers, our customers, our suppliers and all the investors are staying safe at this time. It's clearly a challenging time still. We're incredibly proud of the results in our fiscal third quarter. And again, I want to thank all of our employees for delivering such great results for the company. Thank you all, and good night.

That concludes the Beacon Third Quarter 2021 Earnings Conference Call. Enjoy the rest of your day.