Beacon Roofing Supply, Inc. (NASDAQ:BECN) Q3 2022 Earnings Call Transcript November 5, 2022
Operator: Good afternoon, ladies and gentlemen and welcome to the Beacon Third Quarter 2022 Earnings Conference Call. My name is Megan, and I will be your coordinator for today. As a reminder, this conference call is being recorded for replay purposes. I would now like to turn the call over to Binit Sanghvi, President, Capital Markets and Treasurer.
Binit Sanghvi: Thank you, Megan. Good afternoon, everybody and thank you for taking the time to join us on our call today. Julian Francis, Beacon’s Chief Executive Officer, and Frank Lonegro, our Chief Financial Officer, will begin with prepared remarks that will follow the slide deck posted to the Investor Relations section of Beacon’s website. After that, we will open the call for questions. Before we begin, please reference Slide 2 for a couple of brief reminders. First, this call will contain forward looking statements about the company’s plans and objectives and future performance. Future looking statements can be identified because they do not strictly relate to historic facts or current facts and use words such as anticipate, estimate, expect, believe and other words of similar meaning.
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 2021 Form 10-K. Second, the forward-looking statements contained in this call are based on information as of today, November 3, and except as required by law, the company undertakes no obligation to update or revise any of these forward-looking statements. And finally, this call will contain references to certain non-GAAP measures. The reconciliation of these non-GAAP measures to the most comparable GAAP measures is set forth in today’s press release and the appendix to the presentation accompanying this call. Both the press release and the presentation are available on our website at becn.com.
Now, let’s begin with opening remarks from Julian.
Photo by Nathan Waters on Unsplash
Julian Francis: Thanks, Binit and good afternoon, everyone. Let’s begin on Slide 4. Today, Beacon reported record third quarter results from the top line to the bottom line, including our 11th straight quarter of year-over-year increase in adjusted EBITDA, continuing our track record of profitable growth. Our team’s focus on the day-to-day execution of our strategic initiatives delivered higher volumes across all three lines of business, driving our highest quarterly net sales in history. The strong volume growth also began to unlock the investment we have made in our inventory, resulting in our best quarterly cash flow since the second quarter of 2020. Non-discretionary reroofing demand continue to provide us with opportunities to deliver value to our customers.
Commercial roofing demand remained healthy, while residential growth was supported by repair and reroofing activity across most markets. A few heavy new residential construction markets did slow, but I remind you that 80% of our sales, comes from repair and replacement activity. We continue to make strategic investments in value-creating initiatives towards achieving our Ambition 2025 targets, which is underpinned by the financial flexibility our balance sheet provides. We took an important step this week with the acquisition of Coastal Construction Products, one of the largest independent distributors of specialty waterproofing and associated products in the U.S., which we will discuss in detail a bit later. We also accelerated Greenfield investments, creating capacity, expanding our branch footprint and enhancing service to our core customers.
Along with our share buyback program, our balanced capital allocation demonstrates our commitment to creating shareholder value and confidence in our Ambition 2025 strategic plan. I am very pleased with the progress we have made towards our goals and we will continue to invest in generating profitable growth and returns for our shareholders. Now please turn to Page 5. For those of you who’ve listened to our calls or attended our Investor Day, you are well aware that we have a detailed strategy called Ambition 2025. It is a structured road map with initiatives that are targeted and measurable. As a reminder, the goals we laid out are to grow the business to more than $9 billion of sales by 2025, an 8% compound annual growth rate from our 2021 baseline and to deliver EBITDA of about $1 billion in 2025, approximately a 10% annual growth rate.
Now on to Page 6, I will provide a brief update on our strategic initiatives, which will give you a better idea of how we attempt to achieve these goals. Let me start by highlighting a couple of examples of how we are building a winning culture. We established Beacon Cares 2 years ago to assist employees with unexpected financial crisis and are proud that the fund is supporting our colleagues facing a variety of difficulties, including the impacts of Hurricane Ian. The program also gives our employees the opportunity to help teammates and have their support matched by the company. Also, as we discussed in our last quarterly call, we announced a new national partnership with the charity Rebuilding Together, a non-profit organization providing home repairs for underserved communities.
Everyone deserves a safe home and I am pleased to report that volunteers from our field team, along with Rebuilding Together, recently held a volunteer day to make essential repairs to a home for a family in need. We started in Boston, where Beacon was founded over 90 years ago and helped a couple improve the accessibility features of their home so that they can remain in the neighborhood that they love. We are also driving above-market growth and enhancing margins through a set of targeted initiatives. Expanding our footprint is a major lever in our growth plans, which includes strategic investments in greenfields and tuck-in acquisitions. I am very pleased to report that we have accelerated our investment in our pipeline of greenfield locations.
Our team has ramped up quickly, commissioning 9 branches since the beginning of the year. And while we had originally discussed opening a total of 10 facilities in €˜22, we are on track to deliver 15 new branches this year. Our set of initiatives designed to grow margin is also gaining momentum. We are confident that we provide the most complete digital offering and continue to expand our capabilities to serve customers in the way that brings them the most value. Our most recent digital integration with AccuLynx, a leading provider of all-in-one business management software for roofing contractors is another example of a value-added offering that is driving growth. This integration has helped us achieve a quarterly record with nearly 19% of residential sales going through our digital platform.
We are building upon our technology leadership by continuing to invest in making it easier for customers to do business with us anywhere and any time. During the quarter, we announced the launch of our new Beacon Pro+ mobile app. The new app is custom designed for iPhone and Android devices specifically tailored to meet the needs of contractors who spend their days on the go. Likewise, we also had a record quarter for our higher-margin private label sales. Sold under the Tri Belt brand, these products deliver professional great results and permit our customers to differentiate themselves from their competitors. As we have discussed for several quarters, we are enhancing productivity and capacity through our continuous improvement and operational excellence initiatives.
Over the last 2 years, our focus on the bottom quintile branches has generated tangible results and this year is proving to be even better. We have generated approximately $32 million in year-on-year EBITDA improvements in the first 9 months. You will recall that we targeted a total of $75 million contribution in our Ambition 2025 target. So we have a very strong start on that goal. Finally, our strategic initiatives are designed to create shareholder value, and we are committed to improving returns. Let me highlight that we have repurchased and retired nearly 6 million shares year-to-date. The share buybacks are part of a $500 million share repurchase authorization announced at Investor Day during the first quarter of this year. The share repurchases demonstrate both our commitment to delivering value to shareholders and our confidence in the future.
As you can see, we truly have multiple paths to growth and margin expansion through the cycle. We have a differentiated approach and have built the tools needed to achieve our Ambition 2025 targets. Now, please turn to Page 7 of the deck. As I mentioned earlier, this week we announced the acquisition of Coastal construction products, adding national capabilities in the growing and still fragmented $5 billion specialty waterproofing market. I’m thrilled to welcome the Coastal team of more than 200 employees to Beacon, and look forward to the capabilities and accelerated growth opportunities that this combination brings. This acquisition fits squarely in the middle of our strategic plan. As most of you are aware, we have two core markets, residential and commercial roofing, and our complementary products overlap with the needs of both, providing us with above-market growth opportunities.
As we mentioned at our Investor Day, one of the big areas within complementary that overlaps with commercial roofing is the waterproofing business. This includes corking, sealants and different types of barrier products, essential products and services to our commercial contractors building envelope solutions, both above and below grade. With Coastal, we require a team that is widely regarded as the leading technical authority in the field with specialized expertise. I am particularly pleased that Coastal’s senior team will be joining Beacon with CEO, Martin Harold, reporting to me, leading Beaton’s new specialty waterproofing division. Moving to Slide 8, Coastal is expected to have approximately $250 million in 2022 net sales with around $25 million in EBITDA.
Coastal’s 18 locations serving the Southeast and Midwest will be combined with Beacon 13 branches that are dedicated to specialty waterproofing to form our new waterproofing division. The resulting combination creates an unparalleled coast-to-coast footprint to better serve customers locally, regionally and nationally. At the same time, the waterproofing market is still highly fragmented, offering us ample opportunity to be acquisitive if we find the right fit and room to add new locations as we build on Beacon’s existing capabilities. This includes storm-exposed regions where waterproofing is essential to protecting buildings, adapting to stricter building codes and meeting heightened maintenance standards. After realizing synergies, which include plans for organic growth and footprint expansion, combined with our procurement capabilities, OTC network, digital platform and private label offering, the pro forma transaction multiple is lower than Beacon’s current trading multiple.
This is in line with the acquisition criteria we laid out at our Investor Day. Lastly, I would like to note that this is the fifth transaction we have done in the last 12 months. All have been made possible by the balance sheet strength that we restored early last year. With Coastal, we are able to create a platform for accelerated growth with a transaction that immediately enhances our bottom line while maintaining net debt leverage at less than 2.5x. I couldn’t be happy with the potential we have together. And now I will pass the call over to Frank for some more detail on our third quarter results.
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Frank Lonegro: Thanks, Julian, and good evening, everyone. Turning to Slide 10, we achieved more than $2.4 billion in total net sales in the third quarter, up nearly 29% year-over-year with higher volumes across all three lines of business and higher average selling prices for our products. In the aggregate, price contributed approximately 20% to 21% to revenue growth and estimated volumes contributed approximately 7% to 8%. Our backlog, which peaked during the second quarter, remained at a high level and continues to be weighted toward non-residential orders. Acquisitions over the last four quarters, including Midway, are performing well and more than offset the divestiture of our solar business on December 1, 2021. As a reminder, the results of the solar business are reflected in our prior year numbers as part of continuing operations.
The drivers of our residential line of business remained healthy as re-roofing activity and units under construction supported growth. Single volumes grew by low single-digits year-over-year, well ahead of the market, even with below-average hail and major storm-related volumes year-to-date. In addition to volume growth, higher selling prices year-over-year, including the shingle price increase announced in August, helped drive the 22% residential net sales growth year-over-year. We also want to highlight that the average selling price for shingles increased sequentially from Q2 to Q3. Non-residential roofing sales were up more than 54%, driven by the combination of price execution and increased volumes. Supply chain loosened somewhat in the quarter with improving material availability.
As a result, we started to see the conversion of our backlog, which helped drive one of the highest third quarter volumes in our history. Complementary sales increased approximately 17% year-over-year due to higher volumes across our product categories, including siding and waterproofing. Higher selling prices across all of our complementary product lines, except lumber, also contributed to the growth. As you may recall, our complementary product category has approximately 80% residential and 20% non-residential exposure. The addition of Coastal will adjust these percentages to approximately 70% and 30%, respectively, on a go-forward basis. Turning to Slide 11, we will review gross margin and operating expense. Gross margin was 26.1% in the quarter, slightly higher than our guide.
Price/cost was unfavorable by about 60 basis points as higher average selling prices were more than offset by product inflation year-over-year. Higher non-residential sales mix also contributed to the 100 basis point year-over-year decline in gross margin. Higher sales drove favorable OpEx leverage with adjusted OpEx to sales down 160 basis points year-over-year. Adjusted OpEx was $374 million, an increase of $53 million compared to the year ago quarter. The year-over-year change in OpEx also includes more than $8 million in costs associated with recently acquired branches as well as greenfields and OTC hubs opened in the last 12 months net of our solar divestiture. The increase in OpEx in our existing business was driven by expenses related to the higher volumes and revenues, including delivery, commissions, incentive compensation and travel and entertainment.
In addition, inflationary pressures contributed to the increase in OpEx, including wages, fleet, fuel and lease-related expenses, such as rents, real estate taxes, utilities and maintenance costs. Labor markets for drivers, helpers, warehouse workers remain tight and we continue to make sure that we are staffed to meet demand. As you can see on the chart, our headcount was up approximately 6% year-over-year, slightly less than our estimated volume growth. While we have not yet felt the impact of higher interest rates on our business, we have a track record of agile response and staying ready to adjust to changing market conditions. At the same time, we are focused on investing to drive and support above-market growth and margin enhancement as part of Ambition 2025.
As you have heard, our dedicated M&A and greenfield teams are built out and executing, and we are continuing to invest in our sales organization, customer experience initiative, private label and digital platforms and branch optimization. These and other Ambition 2025 investments totaled approximately $12 million within the operating expense line in the third quarter. Turning to Slide 12, operating cash flow in the quarter was strong at $268 million, the highest cash generation since the second quarter of 2020. This is largely attributable to the $160 million sequential reduction in net inventory as we return to a more normal seasonal pattern with our inventory. On a year-over-year basis, inventory this quarter was higher by $304 million, of which more than three-fourths was driven by product cost inflation.
Inventory from acquisitions and greenfield load-ins also contributed to the increase. We continue to expect inventory to decline in Q4 as we follow a more normal pattern of seasonality and material availability continues to improve. We expect this to contribute to substantial cash flow conversion in the fourth quarter. Our capital allocation plan is balanced between organic and inorganic growth opportunities and shareholder returns. As Julian mentioned, our ability to invest in greenfields and value-creating acquisitions is underpinned by our prudent balance sheet management over the last 10 quarters. As of the end of the third quarter, our net debt leverage was at the low end of the 2 to 3x range outlined at Investor Day, after giving effect to the consideration paid for Coastal, pro forma net debt leverage remains less than 2.5x with liquidity of approximately $800 million.
Turning to shareholder returns, we have retired 5.8 million shares, reducing our common shares outstanding to $65 million at the end of the third quarter. We look forward to finishing the second accelerated share repurchase in the fourth quarter, which is expected to result in the retirement of approximately 1 million additional shares by year end, after which we will have completed just over 75% of the $500 million buyback authorization we announced earlier this year. We continue to have ample capacity to invest in opportunities through the cycle and have laid significant groundwork toward achieving our Ambition 2025 goals. We are confident in our ability to successfully compete in and adjust to changing market conditions and look forward to a successful conclusion to 2022.
With that, I will turn the call back to Julian for his closing remarks.
Julian Francis: Thanks, Frank. Now before we turn the call over to Q&A, I’d like to discuss our outlook for the remainder of 2022. Please reference Page 14 of the slide materials. Going forward, we expect the market fundamentals to remain stable as non-discretionary R&R activity underpins our residential and commercial roofing demand. Commercial sentiment remains favorable, and our backlog remains at a high level, both of which are indicative of near-term demand. At the same time, we expect rising interest rates to bring softness in the regions that have heavy exposure to new residential construction. With respect to Hurricane Ian, let me first say that the communities impacted are in our thoughts. In terms of business impact, initial estimates show the volumes required to repair and reconstruct will be approximately 3 million squares or around 2% of annual industry shipments.
Keep in mind that these volumes will be spread over the next couple of years. For the fourth quarter, we expect a solid finish to 2022. We expect total sales growth to be up between 15% and 17% year-over-year. And please remember that we will be lapping a record fourth quarter in which we saw significant inflation across all three lines of business. Last year, we also experienced additional volumes from Hurricane Ida and had 2 months of contribution from our Midway acquisition. Please note that our guidance includes 2 months of the Coastal acquisition with net sales contribution of approximately $35 million. With respect to gross margin, we expect to see a roll-off of inventory timing benefit in the fourth quarter and heavier non-residential sales mix compared to the prior year.
With that in mind, gross margin is expected to be in the 25% range. Our focus continues to be on the areas within our control, including delivering a high-caliber customer experience as well as daily execution on safety, service, efficiency and pricing. As we enter the winter months, we will balance product availability with our inventory reduction and at the same time, productivity with growth investments. We are increasing our full year 2022 sales growth expectations to 23% to 25% versus the prior year period and adjusted EBITDA in the range of $885 million to $910 million. And importantly, as Frank mentioned, we expect to finish the year with significant cash flow. Now before we head to Q&A, I thought I’d address our early thinking on 2023.
Market demand will very likely be lower next year, especially new residential construction, and we may not see broad-based inflation like we have had the last 2 years. We will, of course, monitor marketing conditions and take appropriate actions as all good companies do. But more importantly, our Ambition 2025 strategy provides us the ingredients for us to grow faster than the market and I firmly believe our strategy is yielding results. We are making investments in our sales organization and our service model. We continue to enhance our digital offering and grow our private brand categories. We are investing in improving our operations, delivering results today, but also getting ready for the future. We are adding platforms for growth that we expect will result in accelerated performance as with the acquisition of Coastal and our additional greenfield locations.
Our business model is resilient, leveraging predominantly non-discretionary R&R demand and our momentum is strong. In summary, we are looking forward to 2023. And with that, we will take your questions.
Q&A Session
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Operator: Our first question comes from the line of Michael Rehaut with JPMorgan Chase. Your line is now open.
Unidentified Analyst: Hi, good afternoon. on for Mike. Regarding bottom quintile brands contributions, how are you guys thinking about that over the next 1 to 2 years?
Julian Francis: Hi, there. Look, I think we have seen really good traction on that initiative. Obviously, we started this shortly after I joined the company and it was a real focus area for us. We continue to believe that focusing on that bottom quintile, there will always be about a quintile. We continue to believe that there is room. We reset that every year. And I think we have underestimated the potential going forward. But I think that overall, we continue to believe that there is plenty of room for improvement in all our branches and the focus on the bottom quintile is showing improvement across the entire range of branches from top to bottom.
Frank Lonegro: Yes. I think what you heard Julian say was we are off to a really good start. We set a target of 75%. We are in the early 30s here year-to-date. And when we get to 75%, we are not going to stop. We are going to keep going.
Unidentified Analyst: Great. And then lastly, I was curious if you guys could give a little bit more color on customer backlogs across your business segments and how they supported sales trend sales trends this past quarter? And if you have any insights in terms of the health of the backlog as you move into 2023?
Frank Lonegro: Yes, another good question. In terms of the backlog, as I mentioned in the prepared remarks, it had peaked in about the middle of the second quarter. When you look at it relative to where backlogs were in the pre-COVID world, it’s still a multiple of that. So we still feel like there is plenty of room left in the backlog. It is more than 50% on the non-residential side. There is the other, call it, 40% or so was split between the resi and the complementary piece with the resi being the larger portion of that remaining 40%. So it’s continuing to deliver for us. It was certainly helpful to unlock some of that in the third quarter and we will continue to unlock some of that in the fourth quarter.
Unidentified Analyst: Great. Thank you.
Operator: Thank you. Our next question comes from the line of Ryan Merkel with William Blair. Your line is now open.
Ryan Merkel: Hey, guys. Nice job this quarter.
Julian Francis: Thank you.
Ryan Merkel: So I wanted to add to your commercial gross margins. I am hearing that commercial gross margins are pretty elevated given what’s going on with supply chain. Can you give us a sense for how much commercial margins are up since 2020 and then what are your thoughts on sustainability as we head into 2023?
Julian Francis: Yes. Thanks for the question. I will start and I will let Frank touch on the details. But look, certainly, we have seen it grow. I think we believe we have done a very good job in terms of executing on the price increases. We have said a number of times that we changed the behavior in terms of executing price increases on the day the manufacturers announced instead of rolling it through. With the number and frequency of and scale, quite frankly, of the price increases, we have certainly seen improvements. Look, we believe that there is also a lot of value created in these. I mean we are looking at value-creating opportunities. I think that there has been a real need to improve the overall margin of this business and we have been focused on doing that as much as we have on capturing inventory profits as we have seen these inflationary environments roll through.
