QXO, Inc. (QXO) Q2 2008 Earnings Report, Transcript and Summary

Welcome to Beacon Roofing Supply’s fiscal year 2008 second quarter earnings conference call. (Operator Instructions) On this call, Beacon Roofing Supply will make forward-looking statements, including statements about its plans and objectives and future economic performance. Forward-looking statements are subject to a number of risks and uncertainties. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors including but not limited to those set forth in the risk factor section of the company’s latest form 10-K. On the call today for Beacon Roofing Supply will be Robert Buck, Chairman and CEO; Paul Isabella, President and COO; and David Grace, Chief Financial Officer. I’d now like to turn the call over to Robert Buck, Chairman and CEO of Beacon Roofing Supply.

Welcome to our second quarter 2008 earnings call. I will begin the call with a few summary comments and then David Grace, our CFO, will present the financial details of our performance. As I’ve done for previous calls, I’ve prepared a few questions and answers covering the important topics that we know you want covered during this call. After I’ve handled the prepared questions, we will open the call for additional questions that you might have. For the quarter, sales increased 6% while organic sales decreased 6.7%, which is a big improvement over the 12% decrease in organic sales during the first quarter, and I’m excited to say that the third quarter is off to a strong start and we are hopeful that trend will continue. EPS for the quarter was in analyst range, albeit on the low end of that range, and our second quarter, which is our winter quarter, is highly dependent upon the weather. You will hear more about our expense control programs on this call and we will explain that gross margins firmed up at our existing branch locations and we also want you to take note of our strong cash flows even during this winter quarter. We want you to be aware of these positives and this performance while at the same time we acknowledge that we can and we will do better. Paul Isabella, our new COO, is on the call, and he is doing a fantastic job executing our business plan of running a lean and efficient company. The third quarter is shaping up well and we have a strong handle on our costs and capital spending. I am also very proud of the officer leadership team and the tough decisions they are making and what I want to do now is turn it over to David and he will give financial results, and then I’ll come back with the Q&A.

In the second quarter of fiscal 2008, our net sales increased 6% to $304.3 million from $286.9 million in 2007. Our quiet markets, which are comprised mostly of [not gross] commercial roofing systems, added $36.4 million in net sales. Our existing markets, which were comprised of 160 branches, not included in our acquired markets, saw a sales contraction of $19.1 million or 6.7%. There continues to be a lower level of new home construction activities, and in some instances, lower levels of re-roofing and remodeling, with flat to slightly declining material prices as compared to 2007. Towards the end of the second quarter, we raised some of our prices to our customers in response to price increases received from some of our suppliers. We do not believe these increases had a material impact on this quarter but they will have some effect in the future. Residential roofing products sales continue to struggle in most of our regions with a drop of 10.5% for the quarter. Non-residential roofing grew by 4.2% with most markets seeing good activity except in the Midwest which was down, mainly due to our harsher winter. Complementary products reacted much like our residential roofing products, down 12.1% and again across most of our existing markets. We estimate inflation in our product cost based upon our current inventory’s product mix and invoice cost as compared to the invoice cost of the same products a year ago. Based upon this estimate, our product costs were flat to fiscal 2007 levels, but as I mentioned, our suppliers have increased prices for residential roofing and some complementary products ranging from 5% to 15% which were effective on February 1st and this has increased our weighted average cost of those products. We closed one branch during the current quarter compared to three openings during the second quarter of 2007. We also have acquired 17 branches since the second quarter of fiscal 2007 and we operated a total of 177 branches at the end of this quarter. We are at 64 business days in both 2008 and 2007 second quarters. Our overall second quarter gross profit was $68.4 million for 2008 as compared to $66.2 million in 2007, a 3.4% increase, with overall gross margins dropping from 23.1% to 22.5%. Acquired markets contributed $6.4 million in gross profit, while existing markets saw a drop of $4.1 million or 6.3%, slightly below the related drop in revenues. Our overall gross margin rate includes the impact of North Coast, mostly non-residential roofing product sales which have lower gross margin rates than our other products. Existing markets had gross margins of 23.2% for 2008, compared to 23.1% for 2007, the second consecutive quarter that we have seen slightly higher gross margins. We have seen the residential roofing product margins improve some with complementary products somewhat flat but non-residential roofing product margins continue to be slightly lower. The residential roofing product margins were enhanced by increased buying before supplier price increases, while the non-residential roofing product margins continue to be hurt by competitive pressures. Total operating expenses increased $4.9 million or 7.0% to $75.3 million in 2008 from $70.4 million in 2007. Our acquired market operating expenses of $9.7 million were offset somewhat by a decrease of $4.7 million or 6.7% drop in our existing market operating expenses due to savings from cost-cutting measures and also somewhat from lower variable expenses due to the lower revenue. Payroll and related costs decreased by $3.0 million, primarily from a reduced head count notwithstanding less favorable medical claims and four additional branches opened since 2007. We also generated existing market savings of $1.1 million in other selling, general, and administrative expenses as we continue to see benefits of our cost out program in many expense categories and also due to allocations to our acquired markets. During the second quarter we expensed a total of $3.7 million for the amortization of intangible assets recorded under purchase accounting including $1.6 million in our acquired markets compared to a total of $2.5 million in 2007. Existing markets operating expenses as a percentage of net sales remain consistent at 24.5%, as we were able to save variable costs as noted above equal to the de-leveraging of our fixed costs. Overall operating expenses increased to 24.8% of net sales in 2008 from 24.5% in 2007 due to those same factors but also the inclusion of North Coast which has a higher operating cost as a percentage of its sales, especially during the winter season. Interest expense increased $0.3 million to $6.7 million in the second quarter of 2008 from $6.4 million in 2007. This higher interest expense was primarily due to the increase in debt from the acquisition of North Coast, partially offset by lower interest rates on our variable rate debt as compared to 2007. An income tax benefit of $5.5 million and $4.3 million were recorded in 2008 and 2007 respectively. The slight increase in our effective rate to 40.5% in 2008 from 40.2% in 2007 is primarily due to allocation changes affecting our state income tax rates. As a result of all I’ve mentioned, we had a net loss of $8.1 million in our second quarter of 2008 compared to $6.3 million in 2007. Net loss per share was $0.18 compared to $0.14 in 2007. Our earnings before interest, taxes, depreciation, amortization, and stock-based compensation or adjusted EBITDA which is reconciled to our GAAP net income in our press release was $2.9 million for 2008 compared to $4.1 million in 2007. Now briefly on to the results for the year to date, sales increased 5.3% to $702.6 million in 2008 from $67.2 million in 2007. Our acquired markets sales totaled $101.1 million, while our existing markets saw a sales contraction of $65.6 million or 9.8%. We estimate that deflation contributed approximately 1% of this decrease year to date. 2008 and 2007 both had 125 business days. Our overall gross profit increased 1.4% to $160.1 million in 2008 from $157.9 million in 2007. Our overall gross margin declined to 22.8% compared to 23.7% while existing markets saw their margins increase to 23.8% from 23.7% mostly due to the same factors I previously discussed for the quarter along with higher calendar year end rebates. Existing market operating expenses as a percentage of sales increased to 22.0% in 2008 from 21.1% in 2007. As we saw a de-leveraging of our fixed costs due to the decreased net sales offset somewhat by the cost savings of our cost out program. Overall operating expenses as a percentage of sales increased to 21.5% from 21.1% due to those same factors offset somewhat by a lower year to date cost percentage at North Coast. Overall operating expenses increased $10.1 million or 7.2% to $151.2 million. In our existing markets, lower head count and our cost out programs helped reduce our operating costs by $9.0 million or 6.4%. We also incurred $7.7 million in amortization of intangibles from purchase accounting in 2008 as compared to $5.2 million in 2007. Interest expense increased by $1.0 million to $13.7 million in 2008 from $12.7 million in 2007 while income taxes were a benefit of $2.0 million in 2008 compared to an expense of $1.7 million in 2007. As a result of all I’ve mentioned, our net loss for 2008 was $2.9 million compared to net income of $2.5 million in 2007. Adjusted EBITDA was $28.0 million in 2008 as compared to $33.3 million in 2007. Net loss per share was $0.07 compared to a diluted net income per share of $0.05 in 2007. Our cash flows from operations increased by $19.4 million or 192% to $29.5 million for 2008 as compared to $10.1 million for 2007. This was despite a drop of $8.0 million in income from operations to $8.8 million in 2008 from $16.8 million in 2007 including an increase of $3.6 million in non-cash charges. However, accounts receivable decreased by $93.9 million in 2008, primarily due to normal seasonal decrease and lower revenues. The number of days outstanding for accounts receivable based upon year to date sales increased somewhat in 2008 due in part to the higher mix of non-residential roofing sales that generally have longer payment terms. Inventory levels increased by $29.0 million as we built our inventories beyond the normal seasonal increase especially in residential asphalt shingles ahead of announced price increases. Inventory terms were down somewhat in 2008 as compared to 2007 mainly due to the drop off in sales and the aforementioned purchasing field. A benefit from the decrease in accounts receivable was also partially offset by a mostly seasonal decrease of $57.6 million in accounts payable and accrued expenses. Prepaid expenses and other assets decreased $6.1 million, primarily due to seasonal collections of vendor rebates receivables. Net cash used in investing activities which consists solely of capital expenditures decreased by $16.0 million in 2008 to $1.2 million from $17.2 million in 2007. We have substantially reduced capital spending due to the business slowdown and the prior years [inaudible] some of our recently acquired acquisitions. Net cash used by financing activities was $23.9 million in 2008 compared to net cash provided by financing activities of $48.8 million in 2007. For the trailing twelve months ended in March, our adjusted EBITDA was $103.3 million and when divided into our net debt of $370.2 million as defined under our credit facilities gives us a ratio of 3.58:1, down from 3.67:1 at December 31, 2007 and still below the required ratio of 4:1. As you can calculate from our recently filed 10-Q statement of cash flows for 2008, we paid down approximately $22 million in debt and increased cash by $3.3 million during the quarter, solidifying our balance sheet somewhat. To recap key points for the quarter, overall sales increased 6.0% with existing markets down 6.7%. Existing market gross margins seem to have stabilized, up slightly to 23.2% from 23.1%. Existing market operating expenses were down $4.7 million for the quarter and $9.0 million for the year to date as we continue to execute our cost out programs with reductions in our debt in our trailing 12 month adjusted EBITDA of $103.3 million remain compliant with our debt covenants. Inventory levels in turn along with the quality of our accounts receivable and related days sales that are outstanding are within our expectations considering the slowdown in the industry. Again, the net loss per share for the quarter was $0.18 compared to $0.14 in 2007, mainly due to the expected seasonal loss at North Coast.

What I want to do now is go through these important questions that are often asked, we’ll get through these, and then we’ll open the call. The first question: which product segment has shown the most firming up of margins? The answer is: surprisingly, non-residential is less stable at this time than any others are although we continue to see sales growth from this segment, albeit in low single digits. Residential roofing product margins, especially with the price increases beginning to take effect seem to be stabilizing while complementary product sales were down in most regions. When you add it all together gross margins in existing regions are up and that is certainly good news. The second question: Existing market sales declined less in the first quarter. Can you give us more details? After a tough December and January, we saw some encouraging signs in February and March although the prior year comparisons are easier. As I’ve said in the past, I am looking for a sustained period of perhaps two or three months of good activity before we might conclude the worst may be over. The Northeast and other northern regions who were hit with an early winter, they rebounded somewhat during the quarter, but then some other areas were sluggish, such as the southeast, midsouth, and west. There are bright spots. Again, the northeast, Canada, Mid-Atlantic, Central Plains, all held up best in the second quarter. Third question: We are all aware of the slowdown in new residential construction. Can you quantify any slowdown in re-roofing? Let’s take a stab at that. As you may know, we do not have a completely accurate method of tracking new versus re-roofing, but maybe we can make a few suggestions to help you understand the situation, so we’ll go through a little math at this time. Let’s assume that 33% of our $135 million in residential roofing sales in the second quarter, let’s assume those were for new housing construction. According to published reports, new housing starts were off 29% in our second quarter of 2008. That calculates to about a $13 million decline in our sales that would be related to new construction and that leaves about $1.1 million drop in re-roofing revenues of $90.2 million and that $1.1 million drop is about 1.2% of sales. We believe again that this mathematical exercise helps show the stability of re-roofing even in very difficult markets. So the fourth question: What areas of cost expense control is Beacon doing the best job? We continue on with what we call our cost out initiatives, which involves a detailed line-by-line scrutiny of all expenses in every region, almost on a weekly basis. We are proactive in this approach. We are assuming a lower level of sales to begin with and then we plan appropriate cost reductions at that level of business. Operating expenses in our existing regions were $4.7 million less for the quarter with about $3 million coming in payroll savings. That equates to about a 6.7% savings equaling the drop in our sales and in our mind, truly an accomplishment considering the high percentage that we have of fixed cost and let me say that we appreciate again the hard work and tough decisions that are being made in the regions to accomplish this. The fifth question is: What was the employee head count at the end of quarter 2 as compared to the end of the fiscal year ’07? The answer is: At the end of our second quarter, which ended March 31, we had 2,431 employees which is down from 2,708 at the end of fiscal year 2007. That’s a decline of 277 employees or 10.2%. Some of the reduction is seasonal, but many are from cost-saving measures, especially in the lower performing regions. Of course, these reduction numbers that I’m pointing out, they do factor out the acquisition of North Coast and wholesale roofing. Next question: Can you comment on the quality of your accounts receivable at the end of the second quarter? We’re happy to do that. Our credit systems are in place in all regions and we believe our reserves are conservative in this area. Our days outstanding are up only three days, partly due to a higher mix of non-residential sales that traditionally have longer terms than residential sales. Our over 61 days past due percentage has improved since December and we’re about 100 basis points below last year including North Coast receivables in both periods for comparable comparisons. So we believe we’ve made it through the winter season in pretty good shape. Next question: Can you update us on Shelter’s performance? We have the right leaders in place now. We have consolidated the central plains region with the Midwest and in addition to that, we have transferred ten other Shelter branches to our North Coast and best distributing regions. Expense reductions are set and they’re being monitored weekly by Paul Isabella and are being achieved. We are on the right track. We need to continue to execute, and with any sales improvement, we will enjoy strong operating leverage. Next question: Can you comment on scheduled price increases from your suppliers? Price increases of 5% to 15% on major asphalt shingles, some vinyl siding products are in the marketplace, and they seem to be sticking. These suppliers have also announced additional price increases for the third quarter. Non-residential manufacturers have also announced price increases in the 5% to 10% range and those are mainly effective for June 1 and thereafter. These price increases in our mind are warranted due to the rise in price of crude oil and we intend to pass these cost increases onto our customers wherever competitively feasible. Next question: Please update us on your debt covenants. Do you have any concerns about them? As David just discussed in his comments, we are at 3.58:1 in our really only pertinent covenant which is adjusted EBITDA to net debt. That gives us about $43 million in availability or cushion if you will and this covenant measurement actually improved in the second quarter due to our good cash flows or pay down of debt and we will continue to monitor this closely. Question number ten: Do you have an update on your guidance for 2008? We are still hoping to improve upon 2007’s earnings per share of $0.56. Although we fell further behind in the second quarter the existing markets actually performed slightly better in that quarter than last year with most of the delta and EPS caused by the highly seasonable period at North Coast and I will tell you the start to quarter three gives us good encouragement. With that in mind, the next question is: How is business going in the third quarter? April went very well. It’s good to see growth again. Some of that may have been pent up demand from winter but it was encouraging. Again, until we see sustained growth for another 60 days, we will remain cautious. The final question before we open it up is: Has anything changed with your acquisition strategy since the first quarter? The answer is: No, not for the near future. It has not changed. Although we are still talking to folks, we are basically on the sideline. The economic reasons for consolidation of this industry, they still remain. However, we do not believe there is a specific timetable nor do we feel the pressure to complete x number of acquisitions in the next several years. We do not want a highly leveraged balance sheet at this point in the economic cycle. We have excellent banking relationships and we want to show them good stewardship. Finally, we do not want to make an acquisition we might regret during these somewhat uncertain times. So basically, expense reductions, grow organically, and improve gross margins. Those are paramount to us. Those are the plays in our playbook at this time, nothing fancy but just solid playmaking. So those are the prepared questions and answers. I hope I have touched on many of the topics that you wanted me to but at this time we do have time to open it up for questions.

(Operator Instructions) Your first question comes from Analyst for Michael Rehaut - J.P. Morgan.

Just a follow up on the price increases of 5% to 15%. We’re actually hearing from some suppliers that they’re actually not able to pass along prices as much as they expected. How much of the 5% to 15% have you been able to pass through? Some of the manufacturers, some of their comments have suggested that they were unable to pass along those price increases to those customers.

I think our manufacturers have been pretty successful. They’ve been very firm and that’s how we are reacting to it, so I’d have to find out more offline of which ones you’re speaking about. At this point, I think most folks are very clear on that because of the price accrued. It continues to increase in our view and I’m sure in theirs they really have no choice.

Just following up with your comments on April, is the growth year-over-year or is it more like sequential, seasonal pick up?

It’s growth year-over-year.

Is that across all business segments and products?

It really is strong, pretty much all, but not all. I think that we do have some summary comments about where the strengths are, the Northeast, Mid-Atlantic, Texas, Canada, southwest, and the Midwest. Our North Coast operation is also doing quite well, so that’s where our strengths are. The West Coast still appears to be flat but everything else is good and when you put it all together, its growth year-over-year.

Just lastly on the cost out initiatives, how much have you saved so far since you’ve implemented that program and how much further do you think you can do on that, and then to follow up on that, if you could break out your cost of goods sold, what the fixed and variable costs are approximately?

We saved approximately $9 million year to date, $4.7 million for Q2. As far as the fixed and variable for the costs, it’s 100% variable. We really don’t manufacture anything or add any costs to those invoice costs that we get from our vendors.

I was under the impression that you said most of your costs were fixed.

That would be our SG&A costs are fixed and we have 60% to 70% of those are fixed but we’ve been actually been able to during Q2 save more variable costs than with the actual de-leveraging of those fixed costs.

Your next question comes from David Manthey – Robert W. Baird & Co., Inc. David Manthey - Robert W. Baird & Co., Inc.: All else equal when you look at the next quarter, given that I think you mentioned that you picked up a bit of an inventory gain from buying ahead of the price increases. Could you quantify that? And then if we look out to next quarter, will the reduction in gross margin as that goes away be offset by an increase from the price increases that are actually being implemented by you? I know that’s a long question but hopefully you got that.

That’s really twofold. One, we made some purchasing deals during the quarter which will benefit us in Q3. Whether that goes away in Q4 is another matter under proper accounting for rebates and special buy income as we call it. That really gets pent up as a reserve against inventory until we sell the product, so we had some of that at the end of December and we have even more of that at the end of March. As far as quantifying by dollars, it’s less than 2% to 3% of our total inventory. David Manthey - Robert W. Baird & Co., Inc.: And then in terms of the non-residential market, on the new construction side, are you seeing signs of weakness there yet and if you could talk about a little bit longer term, have you historically seen any correlation between new non-res construction and non-res re-roofing?

We obviously think that the new non-res construction is the weaker of the two in that marketplace. Re-roofing is such a strong component of that that it’s somewhat difficult to tell, but there is still construction activity in a lot of markets that’s happening, whether that is going to go away at the end of the roofing season in October or November is another matter. As far as in the past, there really hasn’t been much of a correlation. I was here in the early 90s and the new construction basically stopped but the re-roofing is the only thing that kept up the industry at that point of time. So I’m not sure that there’s a direct correlation. I’m sure with the economy that’s happening across the country there is going to be some slowdown in re-roofing, how much it is, I’m not sure. In the past it’s been very small.

Actually the number of regions that showed growth in the commercial area increased in the second quarter so our commercial business did better in the second than in the first so that segment is helping us and the manufacturers still are looking for a good ’08 in that regard. David Manthey - Robert W. Baird & Co., Inc.: Did you see growth in ’01 and ’02 in non-res re-roofing?

We were flat in the fist quarter; well, we saw minor growth in the first quarter, and in the first quarter, I think it’s in the Q we saw 4% growth in non-res commercial in the second quarter. David Manthey - Robert W. Baird & Co., Inc.: I meant 2001 and 2002, Bob.

Oh, I’m sorry.

We actually did see growth in 2001. Remember, our year end is in September, so it was before 9/11 and the effects that happened after that. 2001, I think we had about a 6% drop in non-residential business. A check of that, Dave, though, was deflation and might have been the majority of it. We think unit volume was still okay but we have the great product mix and we’re able to offset that. We actually had some growth in 2002 in total on an organic basis albeit it was less than 2%.

Your final question comes from Justin Harrison - Ramsey Asset Management.

I was hoping that you could comment on some of your thoughts for the back half of non-residential growth. I’m looking at the two year trend because we have pretty much an easy comp this year, so going back the past three quarters, the two year trend in your existing markets seems to be going down pretty strongly from about, quick math, 21% to 3% to minus 10. I’m just wondering what your thoughts are on why that will reverse and why we’ll see some growth in the back half.

Our look-see on the second half is not the return to those robust years. We’re seeing the same slower growth in the second half but our opinion as well as the manufacturers’ is that the second half will be a growth period.

So there will be year-over-year growth on the back half in commercial?

We certainly hope so. That’s what we’re anticipating.

And remember, we had much stronger growth in ’06, upwards to 20% almost throughout the whole year in non-residential roofing, which we felt was much about what the market was doing at that time, so we took some market share and to continue to have even low single digit growth for the rest of 2008 in our eyes is great news to us.

That concludes the questions.

Again, thanks everyone for dialing in and I just have a few closing comments. David and Paul and I will be available post-call for telephone calls, emails, and so forth, so we’ll be available to you. Thanks for your questions and let me close with these points of emphasis. The market was slow in some regions in the second quarter but we’re encouraged by the growth in the third quarter, particularly in the northeast, the mid-Atlantic, Midwest, southwest, and central plains. Our commercial business is still strong for us in most regions including, again, the northeast, Canada, North Coast, which is our acquisition from a year ago, and the southwest. Thirdly, gross margins are firming up which is very encouraging for us because it is happening in a time when we are doing a good job reducing operating expenses. The effect of price increases will be more pronounced in our third quarter since most price increases were announced mid to late March and it appears that more price increases are on the way. In conclusion, we’re controlling our costs for the level of business we have and we are now entering the busy season for our fiscal year in good shape operationally. If business holds up, the performance in the second half will be very encouraging. So that concludes the call and again I appreciate your interest and support in our company and look forward to seeing many of you and talking to you in the future. Thank you very much.