QXO, Inc. (QXO) Q3 2009 Earnings Report, Transcript and Summary

Welcome to the Beacon Roofing Supply fiscal year 2009 third quarter conference call. (Operator Instructions) On this call, Beacon Roofing Supply may make forward-looking statements including statements about its plans and objectives and future economic performance. Forward-looking statements are subject to a number of risks and uncertainties. Actual results may differ materially from those indicated by such forward-looking statements, as a result of various important factors including but not limited to those set forth in the risk factor section as the company's latest Form 10-K. On the call today for Beacon Roofing Supply will be Mr. Robert Buck, Chairman and CEO; Mr. Paul Isabella, President and COO; and Mr. David Grace, Chief Financial Officer. I would now like to turn the call over to Mr. Robert Buck, Chairman and CEO.

This was another solid quarter for Beacon with profits much higher than Street estimates. We delivered great expense controls, along with very strong cash flows. And now with nine months under our belt, it's gratifying to all of us here in the leadership team to report that profits this year are nearly double the same period last year. This is no time for extended celebrations or high-fives around the office because we still have a lot of work to do. However, I certainly don't think there's any wrong if I say a big thank you to all of our employees, many of whom might be listening who worked so hard to achieve these results this quarter and for the nine months. We do have a wonderful team here at Beacon who are really getting the job done in very tough economic times. As has been our custom on these earnings calls in the past, our CFO David Grace presents the financial details right after I speak. In the past we would provide answers to nine or ten prepared questions that we believe were tops on your list. And that's worked very well for us and I've received a lot of good feedback. But in an effort to keep these calls fresh and relevant and meaningful to you, I've decided to change the format a bit for this quarter's call. So after David's presentation, we will go right into a Q&A and we will not be using prepared questions and answers like we've done in the past. Our third quarter results were very encouraging to us. David will point out how our attention to the fundamentals of our business is paying off, and it's paying off in regards to strong cash flows, lower operating expenses and strong earnings per share. We have a solid business plan still in effect that will keep us on track the rest of the year and into 2010. I would like to remind everyone that our business model does serve us well because we're balancing good results in residential roofing with soft demand in commercial. And also our geographic diversity also gives us stability in much the same way, so just a few other points. Gross margins are firm. We continue to receive notices of price increases from various vendors. Our balance sheet is strong because of our attention to accounts receivable, management of inventory, and our efforts to improve debt ratios and return on assets and equity. What I'd like to do now is turn the call over to our sterling CFO who will led us through the financial results and he will do that in his normal proper New England tone. So everyone, here's David Grace and I'll be back after he gives more details about the financials.

Just as a reminder, all of our results for fiscal 2009 are from existing markets and considered organic. For the third quarter, sales decreased 9.9% $463.6 million from $514.6 million in 2008 with residential roofing sales increasing 10.4% as we benefited from the higher year-over-year prices partially offset by volume drops in most of our regions. On residential roofing declined 25.6% as commercial activity has slowed significantly and we did not experience the expected pickup after a rough winter season. Complementary products, which we believe are more discretionary in nature, were down 25.1% and continued to be negatively impacted by both the slowdown in the economy and lower levels of residential construction and remodeling. Regional sales were down, except for in our Southeast area, Southwest and in Canada before the effects of the exchange rate. 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 up 11% to 13% compared to 2008 levels. We also had 64 business days in both 2009 and 2008. We did not open or close any branches during the current quarter or during last year's third quarter. We operated a total of 169 branches at the end of this quarter compared to 177 last year. Third quarter gross profit was $107.8 million for 2009 as compared to $120.2 million in 2008, a 10.3% decrease with gross margins decreasing slightly to 23.3% from 23.4% in 2008. The drop in sales volume is creating some margin presses, but it has been manageable so far. Operating expenses as a percentage of net sales decreased to 16.0% from 16.2% as our regional management has done very well in controlling our variable…

What we're going to do now rather than do the prepared questions and answers, we'd like to open up the call to your questions and we'll spend the remaining time doing that.

(Operator Instructions) Our first question comes from Katherine Thompson – Thompson Research Group.

Following up on your inventory commentary, how much of the inventory increase in the quarter is due to pre-buying activity and could you clarify the timing of this flow through of that inventory?

I wouldn't say it's dramatically different than last year, Katherine. Some of it has to do with the timing of when you make the buys during the month. I would say we turn our inventories currently, especially the residential roofing products, close to seven to eight times so the flow through for that will be through July and partially through August. The pricing has been pretty consistent though so I'm not so sure there's an advantage or anything else like that by doing these bulk buys, it's just what's happening in the market place right now.

And speaking of the pricing environment, could you give a little bit color on what you're seeing right now with overall roofing pricing.

Pricing as I've explained it is very solid to up. In the last three or four weeks we have received notices of price increases that will take effective in August and also September. So pricing is confirmed up and it's reflected also in our gross margin. So our objective as we get price increases would be to pass them on to our customer contractor. So that's what it looks like now. I rarely predict what prices are going to do in the future, but at this point because of asphalt pricing and price of crude and so forth, I would anticipate prices to remain solid with a trend toward up based upon recent activities from our vendors.

Could you clarify the magnitude of the increase?

They're published. I could send you reports that we get and the price increases are usually 5% to 7%.

Is there any lapping, a little bit tougher comps due to Hurricane Ike last September, how do you manage your business around this and how are you thinking about planning your business over the next six to nine months to give in what we've seen some glimmer of hope in the residential housing market?

We do manage the business based upon the business we enjoy. I mean we look at our sales daily. We look out as far as we can with the visibility that we have. Storms are a normal part of our business. Ike really affected more the first quarter of fiscal '09 than anything else, and it continued for six to eight months. If there are storms which people are predicting storms again this year, you would have some more volumes. That's hard to predict but there are folks out there who predict storms. Where it comes, we don't know. We're very strong on the east coast so if a storm hits on the east coast we have more branches involved in that than if it hits the Gulf Coast. Comps, we had an outstanding first quarter of '09 and would anticipate if there were storms again we would have an outstanding first quarter of 2010. The estimates that I see for '09 this fiscal year the fourth quarter look good to us, and so we confirmed that those numbers are solid and we would anticipate performing at that level in the fourth quarter.

Our next question comes from Michael Cox – Piper Jaffray. Michael Cox – Piper Jaffray: My first question is on sales trends as the quarter progressed. I just wondered if you could comment on how those played out relative to your expectation.

They started out more slowly and then firmed up as the quarter went on. The fourth quarter looks more solid than the third quarter but, as you know Michael, it's early in the quarter. But at this point, we can say particularly commercial, that commercial is more solid in the fourth than it was in the third. Michael Cox – Piper Jaffray: On the commercial side of business, I believe you called in your Q some increased competition. I was wondering if you could comment a little bit more about that.

What we're talking about there is just obviously there's less jobs around so the contractors when they do win a job coming back for a second or third try to get better pricing and we don't blame them. We have found a niche with our vendor though and when that happens we all make a decision whether we want to go after the job and sometimes the margins can be a little bit tied up but they've been holding up okay. I mean as you can see we only had a ten basis points drop compared to last year. And that's also said, we're doing a good job out in the field and pricing at the right level to win the business. So it's been firm but we always keep an eye on it and Paul's group does a very good idea on a daily basis watching that. If we see some things that change we're going to go after our people and remind them of what we're trying to do.

I would say our own internal credit policies control a lot on what jobs we take, what contractors we continue to do business with even more than pricing. So, I think most folks would look at our bad debt situation as awfully good management. So in addition to price we watch credit very closely. Michael Cox – Piper Jaffray: Just to clarify on the Ike related demand, is that now behind you in terms of what you're seeing in that region?

Yes, it is. After a while it dissipates and Paul could comment about that. Yes, I think it's pretty much behind us.

Yes, for the most part in the last few months really it's dissipated down to pre-storm levels. So our group in those regions have worked very hard moving to other lines of business or just continue to drive market share gains.

We'll take our next question from Michael Rehaut – JP Morgan. [Ray Wan] in for Michael Rehaut – JP Morgan: This is actually [Ray Wan] in for Mike. First question on the margins, I think historically you guys have talked about 23% to 24.5%, in that range. I'm wondering if you can give any update on this for the fourth quarter and potentially if you guys have looked out into 2010. Also relating to that, if you can give us some color on the margin trend side in each segment of the quarter, like if they're up or down sequentially year-over-year.

I think we'll pretty consistent of where we are dependent upon product exchanges. As you know the commercial non-res products have 800 to 900 basis points lower gross margins so if we see a shift there you may see it drop towards that lower end of that 23 to 24.5, but we're pretty comfortable with the range they're in now. I think that will continue into next year. It's hard to predict the future but in reality if that product mix stays the same way it is we'll be consistent. By product group, margins in the commercial products they're within the range they were last year. We do have some areas of the country where it might be a little bit more competitive in a branch or a region. That happens all the time. The average prices actually went up slightly average gross margins went slightly in commercial products for the quarter. They were about flat for complementary in the non-residential roofing once you include the incentive incomes in there. So we're in good shape right now. [Ray Wan] in for Michael Rehaut – JP Morgan: Is that on a year-over-year or sequentially basis?

Both. [Ray Wan] in for Michael Rehaut – JP Morgan: On the commentary about July and the fourth quarter so far, was that on a sequentially basis or year-over-year basis or give some more color on that in terms of just magnitude of your growth or declines.

That's a comparable periods. So that would be fourth quarter of this year versus fourth quarter of last year. Michael Rehaut – JP Morgan: So we got [inaudible] sale so far up on year-over-year basis for July?

No what I was stating is the start to the fourth quarter particularly in commercial area was better than in the third.

Remember, Ray, we're starting to anniversary all the price increases. The vast majority of them happened before July of last year. So we're going to start seeing that less of a price increase for our revenue increases and more matching to just volume changes.

We'll take our next question from Ivan Marcuse - KeyBanc Capital Markets.

On a non-res side of the business you said you saw some price increases. Are you getting price increases more from the residential or from the non-residential and then on top of that, you said non-residential has improved toward the end of the third quarter, would you think that you should see the same type of volume decline in the fourth quarter or it would be a little bit less on a year-over-year basis.

The price increases in recent weeks were more residential. What we are hearing, I think even heard that on Carlisle's who is a commercial manufacturer. Their earnings call was they would like to see price increase happen as well, but the firm announcements of price increases is mainly from residential.

Do you expect volume in the non-residential side to probably stay about equal to what you saw this quarter or do you see a gain, I know there's a little bit of seasonality to it but do you see it staying about the same or getting worse? Where do you see the trend on a year-over-year basis?

Well the trends in July showed improvement but, again, that's too early to predict what the quarter would be.

The operating expenses did a great job there. Do you think you'll be able to maintain that same level going into the fourth quarter or do you think you'll see a little bit of a bump up since there's a little bit more business ticking in the fourth quarter?

We should see relatively same level or even improved on a percent basis as we go through Q4. Our regions have done a great job of maintaining cost control, headcount control and overtime control. So we feel very good about that.

Before we get to the next question, [Brendan], back to expense controls, it might have been lost a little bit in David's presentation, and he's frowning at me now, but anyway. What I want to say is on a sequential basis, and these are pretty dramatic numbers, sales in the third quarter were $143 million higher than the second quarter. And that's seasonal in nature. But that's a 45% increase in sequential sales, normal for our business. Operating costs went up $1.4 million on that $144 million. So I just wanted to add that and Paul and David and I were talking about that prior to the call. That really demonstrates the real positive operating leverage that we get in our business. So as the economy turns, as commercial firms up we are so well positioned to have great operating leverage. So I just wanted to put those numbers in there because there are a lot of folks who are making that happen so sales up $144 million and cost up $1.4 million, that's a pretty outstanding business model. So go ahead [Brendan], I just wanted to add that in.

Our next question comes from Ryan Merkel – William Blair. Ryan Merkel – William Blair & Company : Could you give us the volume and price breakdown by product category?

As far as the residential products, which have the largest amount of price increase obviously, we think we're down about 15% in volume, which would mean that the price increases are about 25%. It's probably a little bit high because the price increases happened during the third quarter of last year. And it's a little difficult to actually do the actual calculations. But a good estimate would be 15%. As far as the commercial products, it may have about another 2% to 3% in price in there so it's a little bit more down in volume. The complementary, it depends really on the group, what I would say about that is some of the down a little less and some of them up a little bit more than the actual total change. Ryan Merkel – William Blair & Company: On the price increases, given that you're lapping the price increases from last year and then it sounds like you may be getting some more increases in the 5% to 7% range, can you give us an idea of what the price might be in the fourth quarter?

I don't think the price increases that are announced late August and September will affect us at all, so I think you would compare that to last year's quarter and I think by the end of the quarter they're obviously going to be up 25% to 30% like we said last year. But I think probably you'll see a mix so maybe 2/3 of that will go away this quarter. So you'll see much lower overall inflation factor when we announce it in November/December.

We'll take our next question from Ivan Holman – RBC Capital Markets. Scott Ciccarelli in for Ivan Holman – RBC Capital Markets: It's Scott Ciccarellli. First of all can we talk a little bit more about the non-residential business, were there weather impacts or any other disruptions in the quarter or was it just a lower run rate of the business?

Rain will affect the non-residential to a great extent. New England, particularly the greater Boston area, was extremely wet in the spring and David lives there he can comment more on that, but it was day after day. That has a big affect on the commercial business. And then as we are looking at July, you have a different situation and then their numbers are better than they were in the third quarter because it is drying up. Scott Ciccarelli in for Ivan Holman – RBC Capital Markets: I guess what I'm trying to grapple with here, Bob, is if re-roofing is such a big chunk of that non-residential business, let's call it 80% and sales are down 25% obviously the re-roofing part was impacted and I'm trying to figure out how much of that was the external disruption and how much was just the lower run rates because of what's going on with the commercial real estate market. Any other color you can provide would be helpful.

Re-roofing is the primary part of commercial business. By region that can be different because of new construction activity but re-roofing dominates our New England business. It's a big part of our Southwestern business so that hasn't changed.

The only thing I would add is [Kahla] was probably down about 35% so we did a little bit better than we did obviously there in some different markets and we. Just some color from what we're hearing from the field, this non-reaction of this stimulus plan to really put any money out on the street for the cities and towns to do the repair work seems to have slowed down some of the [wadding] or bids. But that's anecdotical and I'm not so sure that's a driver but there could be some other cause. Like Bob said, July looks a little bit better so maybe some of the money is being released.

Through this whole period quoting activity has been relatively strong, if that's an indicator, and at some point those jobs will get awarded.

We'll take our next questions from David Manthey – Robert W. Baird & Co. Kyle O'Meara in for David Manthey – Robert W. Baird & Co: This is Kyle O'Meara in for Dave. Could you quantify the hurricane contribution to the quarter and more importantly looking out over the next two quarters, I think last year you said probably about a 15 million to 20 million contribution to the fourth quarter and 30 million to 40 million in the first quarter. Does that sound about right to you guys?

No, it would have been the Q1 and Q2 of last year. We really didn't see any appreciable effect in our Q4 of last year from Hurricane Ike. Now there was obviously some more hail damage last year than we've seen in some of the markets we're in and that would have had an effect on Q4 of last year. Kyle O'Meara in for David Manthey – Robert W. Baird & Co: And for the current quarter was it minimal contributions from hurricanes?

If any. Kyle O'Meara in for David Manthey – Robert W. Baird & Co: I don't know if you have it in front of you, the days for fiscal 2010 on a quarterly basis, selling days?

Yes, I can send that to you.

We'll take our next question from Brent Rakers – Morgan Keegan. Brent Rakers – Morgan Keegan: I wanted to follow up on there was some questions earlier about the non-residential markets. And I appreciate the additional color in the Q with the regional data, but I was hoping maybe you could take it a step further and talk about how non-res performed in the period both in the Northeast region and then maybe separately how it did in the upper Midwestern region.

I think we're seeing the same softness in almost every area. [Inaudible] who's in the Midwest region, there's no question that they've seen a slowdown, and whether it's temporary or not is really the question. In New England, as Bob mentioned, we had quite a bit of rain. I don't like using weather as an excuse and neither do our folks, but that could delay some things and we're hopeful that things get back a little bit more to normal in August and September. Bob said there was an improvement in July. That's pretty much across all the regions. I don't think it's anything that's regional in nature. We're strongest on the Northeast. Canada did very well during the quarter, and the Midwest fell off. I mean, as you said, the numbers are in the Q now. Brent Rakers – Morgan Keegan: Okay and then just one other question. There's some commentary about gross margin. And it seems maybe to show up a little bit in the inventory as well. But you had a kind of a special buy opportunity from some of the shingles suppliers and maybe that helped the gross margins. I guess, first is that so? And second, how much did that impact the quarter? And will that have ramifications for the next quarter as well?

I think that the special buys are just the vendor's way of adjusting their prices temporarily. That happens all the time. Normally it doesn't happen into the summer season, but because of some of the softness, I think that will continue on a little bit. When it ends, I'm not sure that's based upon how they arrange their production and how much they want to keep their plants running. That's really their decision of how they go to market. Brent Rakers – Morgan Keegan: David, do you have any degree in terms of what the impact was in this quarter?

I don't. It's a blended rate. It actually goes right into our cost, Brent. We don't track at that accurately as far as the weighted average cost system.

Our next question comes from Saul Ludwig – Key Banc.

Great job on the operating expenses coming down $9 million, how much of that $9 million was things like commissions were down and your diesel fuel was down which happened just kind of by themselves? And how much of the decline in operating expenses was management action where you actually took steps to lower your cost?

Paul, you got that?

Yes, I do. Well, first you got to look at the biggest piece and that's the headcount where we had just about a 9% decrease in headcount year-over-year which is [inaudible] payroll. To a lesser extent we had impact from fuel. But overall, I'd say the majority of the actions and commission plants, the majority of the actions were from management. Actions that we had taken over the last number of months to adjust our costs for the sales volume.

And these staffing reductions were they just people who work in the various branches and load trucks? Or were they sales people? Or are they temporary cuts? Or are they going to have to come back?

No, well they'll come back if volume increases substantially. As we talk about the sequential, if you look at, as Bob mentioned, Dave mentioned earlier, the sequential volume gain we had from Q2 to Q3 was substantial and we held cost relatively the same. And actually headcount went down slightly. So yes, the majority of these are not temporary headcount reductions. It's not something we did knee-jerk just to survive a quarter. We did it through our normal process of trying to be as efficient as we possibly can.

And just to circle back on this. This $9 million reduction in operating expense versus last year, would you think say $3 million of it came about just because of commissions and fuels and $6 million was management-initiated actions? Or would you split it different than that?

I would say that you're not that off. Saul, the commissions are not down that much. Remember gross margin percentages only went down 10 basis points and we were down 9% in sales volume. So I don't think that's a major impact. Now some of the incentive-based pay because last year was such a strong quarter does certainly affects that. But fuel really kicked in Q4 last year where we saw the substantial price increases. We are also saving because we bought some new equipment and those types of things that always happen. But in almost every expense category that we have in our SG&A line, we've seen some savings. So whether it's temporary or not, some of it has to do with the times. And we need to make those correct decisions when we're spending the money for our stockholders. And I think we've done a very good job with that.

Our final question comes from Joe Gagan – Atlantic Equity Research.

The question about the residential roofing business and what happens to sales results after there's a lot of storm-related demand. So you have 21 of your 170 offices are located in Texas, right? And you've outlined over the last several quarters how you've generated a lot of business because of Hurricane Ike, right? So I just wanted to get your confirmation. I would assume that after an area gets a lot of business because of a storm that would mean that the following periods that have significantly less because a lot of the people have replaced roofs that have been thinking about it because of the storm. So I think you said earlier that most of the storm-related business is gone. So could we infer that because you have so many offices in Texas out of your whole percentage that that's going to be a significant hit to residential roofing sales in the future? And then I have a follow-up to that.

Well, Texas is not the largest concentration of locations at all. The biggest concentration would be the Mid-Atlantic, New England and Southeast. About 10 or 11 branches were affected by Ike, so not all branches in Texas were affected. And you're correct. A storm has the tendency of causing replacement of roofs in a compressed period. So you might have a re-roofing activity in a nine month period that could be equivalent to what would have happened in two years. So that does happen. Our objective is to grow through all those cycles. And if you look at total roofing demand over the years, including storms, it's very steady growth because one year the storm is in Texas nationally and the next year it hits the east coast. So, total roofing demand is very stable because storms move around. So to us, we really don't make our business plan based upon any storms. We don't project for it, budget for it. But the folks who are running Texas and other parts of the country put a budget plan together post-storm that includes other segments, additional complementary products to replace the bulge in storm demand. So it's pretty normal. There were two years in our company, fiscal '06 and '07 where there were no storms. And so fiscal '09 is more normal, where there is one major storm somewhere in the United States that would hit beacon locations. So the expectation is that every year there will be that kind of activity. To us, the more abnormal situation is when you have a year of no storms. So I would anticipate fiscal '09 and '10 would be pretty normal regarding that.

Then I have a question on the residential roofing business. I've done some survey work with roofing contractors all over the country, right? And these guys were telling me that their residential roofing business was year-over-year was down. And many of them said it was significantly down, right? And yet you had 10% increases in your residential roofing business, right? And so now we're sitting here at August 7, right? So you must have a feel for what's going on. Now you've already commented and said that your non-residential is improving. So I'm just trying to figure out in my mind what's going to happen with this residential business specifically. Can you comment on that because it seems like the 10% is a good result. And it seems that it might be difficult to continue.

Well, I think I commented earlier about estimates from fiscal '09 that we were comfortable with. Residential, we are not in states like Florida and Arizona and Nevada where new construction is a dominant activity. But re-roofing is also very high in residential areas. So we think that's one of the more stable parts of our product segment. We've had five quarters in a row of growth and residential and the housing market hasn't turned yet. So think of that where you have the worst housing market in history of the United States and our residential segment has been growing for a year and a half. So as that turns and stabilizes, whether it's because of government stimulus or mortgage rates being low, who knows what, we think residential in the future looks very positive to us.

That concludes the questions. Now, I'd like to turn the call back over to Mr. Buck for his closing comments.

Thanks everyone for your questions. I do want to remind you that Paul, David and I will be available for follow up questions at the conclusion of this call. And with just a few minutes remaining, let me close with a few summary comments. First, gross margin percentages were solid in the quarter and on a year-to-date basis they've improved 90 basis points compared to last year. Operating expenses are lower as a percent to sales for the quarter and year-to-date and that's only possible because of our management team. That team runs a lean and clean company, which is a core value of our culture. Operating income, net income and earnings per share on a year-to-date basis are all up significant and we're proud of that. And finally, we take pride in our reputation as good financial stewards. We recognize that this company and its resources are owned by the shareholders, not the management team. So we are merely caretakers. All of our decisions are based upon cherishing our employees and keeping our resources safe and secure for our shareholders. Because we focus on those two groups, it keeps us very well grounded. So we're excited about the first nine months of '09. I think we exceeded estimates throughout the fiscal year. So I really want to conclude just by thanking you again for your interest and support of Beacon. Our employees do get motivated by your support and their dedicated to delivering good results in the fourth quarter, and we're ready for the opportunities that await us in fiscal '10. So I appreciate your interest. Thanks for calling in and call us with follow up questions and we'll be available. Thanks very much.

That concludes today's conference. Thank you for your participation.