Beacon Roofing Supply's (BECN) CEO Paul Isabella on Q4 2016 Results - Earnings Call Transcript

| About: Beacon Roofing (BECN)

Beacon Roofing Supply, Inc. (NASDAQ:BECN)

Q4 2016 Earnings Conference Call

November 21, 2016 5:00 PM ET


Paul Isabella – President and Chief Executive Officer

Joe Nowicki – EVP and Chief Financial Officer


Keith Hughes – SunTrust

Kathryn Thompson – Thompson Research

Phil Ng – Jefferies

Jason Marcus – JPMorgan

Ken Zener – KeyBanc

David Manthey – Baird

Garik Shmois – Longbow Research

Ryan Merkel – William Blair


Good afternoon, ladies and gentlemen, and welcome to Beacon Roofing Supply’s Fourth Quarter and Fiscal Year 2016 Earnings Conference Call. My name is Carmen, 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. [Operator Instructions] As a reminder, this conference call is being recorded for replay purposes.

This call will contain forward-looking statements including statements about its plans and objectives and future economic performance. 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 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, November 21, 2016, and except as required by law the company undertakes no obligation to update or revise any of these forward-looking statements.

Finally, this call will contain references to certain non-GAAP measures. The reconciliation of those non-GAAP measures is set forth in today’s press release. This company has posted a summary financial slide presentation on the Investors section of its website under events and presentations that will be referenced during management’s review of the financial results.

On the call today for Beacon Roofing Supply will be Mr. Paul Isabella, President and CEO; and Joe Nowicki, Executive Vice President and Chief Financial Officer.

I would now like to turn the call over to Mr. Paul Isabella, President and CEO. Please proceed, Mr. Isabella.

Paul Isabella

Thank you. Good afternoon and welcome to our 2016 fourth quarter earnings call. Similar to recent quarters, we’ll be filing our 10-K later this week. As described in our press release, 2016 was an excellent year for Beacon, a year that resulted in record setting performance. The year began with our successful acquisition of RSG and then we closed and integrated another seven acquisitions over the course of the year.

During the year, we delivered exceptional growth, increased margins. We reduced our debt ratio per our plan and efficiently integrated the eight acquisitions. At the beginning of the year, we laid out many deliverables related to the RSG acquisition and we achieved or overachieved on all of them.

In total sales were up 64% with 10% - approximate 10% organic growth, gross margins increased by 80 basis points and gross margin dollars exceeded the $1 billion mark for the full year, and existing market expenses declined 50 basis points. We had adjusted net income growth of 83% over the prior year and a 106% growth in adjusted EBITDA. More importantly, we have remained extremely focused on our customers. I can’t say enough about Beacon’s loyal customers and employees that made 2016 a great year and we are looking forward to a successful 2017.

Q4 saw Beacon produce another record quarter for both sales and earnings. Quarterly revenue growth increased nearly 49% driven by the fiscal year 2016 acquisitions and organic growth of 2.4%, which adjusted for price was approximately 4% unit growth. Growth in the quarter was fueled by strong residential organic growth of 9.1%. Our fourth quarter residential organic growth represents our ninth consecutive quarter of mid-to-high single-digit sales growth within this segment.

Q4 revenue of nearly $1.2 billion represents our second quarter in a row of sales of over$1 billion. We had expected high organic growth in the quarter. But a number of factors including extreme heat in some markets and the impact of the milder winter and resulted demand pull forward impacted sales. As we have said before these near-term impacts we believe will balance out over the course of the year. And we’re proud to have reported another record quarter of EPS, which Joe willdetail in his remarks.

Four of our seven reported regions reported positive growth during the quarter. As with Q3, our Southwest region produced the strongest geographic growth rate at 25.4% driven in large part by the Texas storm related demand. The Southeast also delivered good growth of approximately 7% driven from strong residential sales. We also posted positive year-over-year growth in the Midwest and Mid-Atlantic regions. Our West, Northeast and Canadian regions saw negative organic growth during the quarter driven primarily by commercial products, which these regions have heavier concentration off. Again, as I said we’ve seen these fluctuations in the past by quarter and by region and though they will improve as we go through the year and beyond.

On an organic basis, sales were mixed among our three primary product lines with strong sales growth within residential as already noted, flat sales for complementary and modest declines for commercial. As I mentioned earlier, organic sales were 9.1% with particular strength in storm impacted regions. Re-roofing check trends remain positive in most markets and we continue to experience positive contributions from greenfields opened in previous years. Q4 marked 10 consecutive quarters of positive growth within this product segment.

Complementary sales were essentially flat year-to-year. We have seen this product line fluctuate quarter-to-quarter over time and have confidence we will continue to see growth here. We believe this segment has strong growth potential as remodeling spends improve and we work to drive sales acrossed our branch footprint. In particular and as we’ve mentioned in the past, we continue to drive cross selling of complementary products within the RSG footprint.

Our commercial product line experience approximately 6% sales decline in Q4. Adjusted for price loss in the quarter, unit volume was down approximately 4%. The combination of tougher comps in some markets pull forward sales in the impacted areas, which I mentioned, you recall Q2 of 2016 was up organically 24% for commercial products noting the pull forward. However, commercial market indicators remain attractive. We expect improved sales performance in the future.

I think the broader indicator is full year sales growth for our product lines. Full year organic growth was up 9.5%, residential organic sales were up 14.1%, very strong, and commercial products were up nearly 5% and complementary up 7.6%. Very strong performance for all three lines of business, and I’m confident that all three of these product lines will continue to be positive in 2017.

As I said, quarterly sales trends will fluctuate based on many factors. We believe we can deliver solid yearly results regardless of the quarter-to-quarter changes due to the factors I mentioned. We had exceptional gross margins in the quarter and ending at 25.7%, which Joe will detail during his portion. And has been the case throughout 2016, we experienced a low-single digit price decline in Q4. However, as highlighted by our gross margin strength, we were more than able to offset this headwind with lower product costs. Importantly, the rate of roofing price declines has slowed in the last few months sequentially from Q3 we gained approximately 90 basis points on residential pricing.

In summary, our residential roofing segment was a standout performer in Q4 both in terms of topline performance and gross margin contribution. For the quarter operating expenses were up 30 basis points in existing markets. The increase in the quarter was driven primarily by the softer than expected sales volume as per my earlier remarks and a higher cost to serve due to the residential mix being higher. For the full year as I mentioned, we saw solid decrease in existing expenses, good leverage as we continue to make prudent reinvestments in the business.

With regard to acquisitions, we completed eight total transactions during 2016 as I mentioned, excluding the RSG transaction these other seven deals have added annual revenues of approximately $200 million. Even more important these acquisitions have allowed us to further expand the geographic – geography such as the Pacific Northwest, Colorado and Michigan and also expand our product diversity. This expansion will continue as we look to strengthen various markets across the country. And as we’ve said in the past, we will continue to open greenfields. We have already opened one this year.

Related to acquisitions, the timing of them remains difficult to predict as I’ve said in the past, but our pipeline remains full and our dialogue with owners remains active. We will remain aggressive on the M&A front as well as fund our internal growth initiatives, while still managing to reach our 2018 targeted leverage ratio.

And now a little bit on 2017 guidance expectations. We’re providing an initial total revenue growth range of 3% to 7% for 2017, which assumes 2% to 5% organic and an approximate $75 million contribution from the seven transactions completed in 2016. We have intentionally expanded the guidance range to begin fiscal 2017 with plans to narrow it steadily as we obtain increase visibility throughout the year.

For adjusted EPS, the current published ranges $226 million to $265 million. At this point in the year, we believe the lower end of the range is reasonable. We will tighten this range as we go through the year similar comments I made on sales. We are committed to growing sales and margin for the year. We have our teams very focused on doing just that. Key industry metrics appear favorable for 2017 do residentially commercial starts, remodeling spend, existing home sales to mention a few are all projected to increase during the year. This shows the continued strength of our industry. And as a reminder we’re 80% re-roof, which highlights the non-discretionary nature of roofing.

In summary, we’re very pleased with our full year and fourth quarter performance in a very excited about 2017 and beyond. We remained confident in our growth path for years to come.

With that, I’ll turn the call over to Joe for his additional comments. Thanks.

Joe Nowicki

Thanks, Paul, and good afternoon, everyone. Now I’ll highlight a little more detail on a few key financial results and metrics that are contained in our earnings press release and the Q4 slides that have been posted to our website. Similar to the past several quarters, we’ve included a few extra slides to help explain the results in more detail. And in my prepared remarks I’ll go into greater detail on gross margins, operating expenses, inventory synergies and our outlook for 2017.

As Paul said, it was a very solid quarter that topped off an outstanding year. But the quarter, we delivered strong topline growth of 49.1% for record fourth quarter sales of $1.17 billion. This was driven primarily by the 8 acquisitions we made in 2016. Gross margin increased over the prior year by a 140 basis points. Operating expenses were up overall, but primarily related to our active acquisition program. For the quarter, we achieved a record adjusted EPS of $0.88 an improvement of $0.13 versus the prior year. And our fourth quarter adjusted EBITDA grew 64% to $127.5 million from $77.7 million in the prior year. For comparison purposes there were the same number of days 64 in both Q4 of 2016 and Q4 of 2015.

Paul already went through our Q4 sales results as shown in Slide 3, so I won’t repeat any of that information here. But I will go through our monthly organic sales trends, all of which increased on a year-to-date basis. July daily sales grew 5.1%, August sales were up 0.6% and September sales were up 1.9%, and that growth continued in October with organic sales up 2.3%. The slightly softer growth in August was primarily a result of the very high temperatures across most of the nation, which makes roofing very difficult.

Within the quarter, our residential business had consistently high growth rates in every month, up 11% in July, 7% in August and 9% in September and that high growth continued in October where residential sales were up 10%. On a very positive note the gross margin rate was 25.7% for the quarter, which is up 140 basis points from a year ago. This marks the highest gross margin rates since the second quarter of 2004 going back prior to our initial public offering.

The majority of our gross margin gains resulted from a product cost decline of roughly 3% mostly from residential products, which aligns with our purchasing synergies as a result of the acquisitions. Product pricing declined approximately 1.5% although pricing continues to show sequential improvement. Price changes can vary significantly between geographies based on a variety of factors including market demand, competition and storm related demand. Our expectations are for prices to continue to stabilize through 2017. By specific product category, our residential and commercial average prices declined 1.5% to 2%, while complimentary pricing declined 0.75 of a 0.1 on a year-to-date basis.

We point out that this residential roofing price decreased represented the smallest decline in 2.5 years, as Paul mentioned sequentially we continue to see improvement. Our commercial product cost declined 200 basis points to 300 basis points. Our residential product cost struck 400 basis points to 500 basis points during the fourth quarter. Complimentary product cost declined comparable with our pricing decrease. The mix impact in our business drove approximately 20 basis point improvement in our gross margin as our mix shifted to higher proportion of residential roofing products, which carry significantly higher GM rates.

Residential represented 54.5% of sales versus 49.9% last year. And commercial was 30.2% compared to 34.7% a year ago. Direct sales declined 60 basis points from the prior year, which also contributed to increased margin in the quarter.

Now moving on to operating expenses, total operating costs were $206.2 million, 17.6% of sales. Excluding the non-recurring cost was $7.1 million, adjusted operating costs were 16.95% of sales. The $7.1 million consists of $1.4 million of non-recurring acquisition costs and $5.7 million of amortization step up from the RSG deal.

As you can see on Slide 4, existing operating expenses is a percentage of revenue for the quarter increased by 30 basis points year-over-year. The primary driver was in compensation related costs as a result of the higher mix of residential volume during the quarter and the slightly lower volumes anticipated. These are partially offset by declines in our bad debt expense and business insurance combined with the leverage of our operating costs across the new acquisitions.

In total, we were not able to get the full amount of leverage we were looking for in the quarter. As mentioned above, the two key factors were the mix of business and the lower than planned sales volume. As we previously discussed, our residential business has higher gross margin, but also higher operating expenses. The mix shift this quarter residential volumes drove almost 30 basis points of difference and operating expenses.

In addition, we anticipate a slightly busier quarter and had the staffing related cost ready to handle it. When it didn’t occur, we wanted to keep a headcount on Board is still in our prime selling season through October and early November.

As shown on Slide 5, the Beacon and RSG integration teams did an outstanding job of exceeding our synergy targets for the year. As you may recall our national estimate when we completed the deal was for synergies of $30 million. Then in Q3 we revise it upward to $35 million. We were able to achieve approximately $40 million in cost benefits for the year and we continue to target $55 million savings through 2017. Essentially representing a full year run rate of our most current second half 2016 trends.

As you may recall, we’ve previously identified three major areas synergies, branch consolidations procurement and other SG&A benefits. To-date we consolidated 30 branches with one location closed during Q4. We continue to review our remaining overlapping RSG Beacon locations and will make decisions based on economics in a similar matter to how we’d evaluate all of our branches. Currently, we have three to five additional branches under consideration for consolidation approximately a third of our year-to-date savings came from branch consolidations.

Regarding procurement we’ve made great progress there as well, as we’ve purchased material on new contracts and sell through inventory we realized the purchasing savings. As I commented last quarter, our procurement savings accelerated significantly during Q3 and as expanded further in Q4. A significant portion of our fourth quarter synergy upside was tie to this gross margin line benefit. For the year, procurement savings accounted for over 45% of the total synergies.

Finally, we captured significant operating cost savings tied to the elimination of duplicate headcount at the corporate level. Paul mentioned previously, we have now shifted our focus toward the realization of revenue synergies between the two entities. While this is not part of our formal budgeted RSG opportunity, we believe there will be a meaningful sales benefit for both the RSG and Beacon platforms in the future.

Interest expense and other financing cost increased $13.9 million versus the prior year, but there was $2.1 million of one-time cost related to the re-pricing of our term loan B facility. In the year, our borrowings have increased over $900 million tied to the purchase of RSG in the seven other acquisitions completed during the year. We’ll continue to make efforts to deleverage our balance sheet over time and I’ll address this further when I talk about our balance sheet in a few minutes. Our effective tax rate for the quarter was approximately 40% after adjusting for the one-time RSG related expenses our adjusted effective rate would have been a little over 39%, which is essentially in line with our expectations. But as a reminder, our cash tax rate was substantially lower for the year at 18.2%. We were able to utilize nearly $40 million in NOLs during the 2016 related to the RSG acquisition. This is a significant part of our acquisition strategy in an attractive addition to cash flow. This allowed us to further pay down our debt.

Our net earnings were $47.4 million for the quarter or $53.6 million on adjusted basis compared to $37.8 million adjusted earnings in the year ago period. Diluted EPS were $0.78 as $0.88 on an adjusted basis compared an adjusted $0.75 from the year ago quarter. Adjusted EBITDA for the quarter was $127.5 million representing 10.9% of sales compared to $77 million in the prior year 9.9% of sales. The outstanding year-to-year improvement driven by higher revenues and excellent operating performance.

Now I want to provide some clarity on the one-time expenses that we show on the adjusted EPS and EBITDA tables within our press release and also on Slide 6 of the earnings release. We incurred a pretax total of $9.3 million in one-time cost in the quarter and $59.5 million year-to-date. For the quarter $1.5 million of the costs are tied to the integration including severance costs and lease terminations, $2.1 million relates to the financing costs and other expenses from the RSG acquisition and $5.7 million relates to the RSG amortization step up.

Slide 7 provides even a little more detail breakdown of our total amortization costs for the year including and excluding this incremental amortization cost. Regarding the status of our balance sheet, first let me talk about cash flow generated.

As noted on a Slide 8, cash flow from operations for 2016 was $120.6 million compared to $109.3 million in 2015, great cash flow driven primarily by our strong operating results. Additionally we also measure and track our performance in key areas such as inventory, AR and AP plus overall balance sheet metrics around working capital as a percentage of our sales.

Slide 9 provides more detail on our inventory. Total inventory turns were 5 in the quarter versus 4.9 times last year. Inventory turnover has been a key metric you had focused on throughout the year, we’ve made great progress. Our accounts receivable days sales outstanding, improved from 36.1 days last quarter to 34.4 days in Q4. Our days payable outstanding have remained consistent at around 30 days. Our working capital increased to $765 million in 2016 from $467 million in the prior year. But as a percentage of revenue average working capital declined from 17.6% last year to 15.6% this year.

We’re making great progress here to the leverage of our acquisitions combined with tighter controls. CapEx excluding acquisitions for the 2016 year was $26.3 million compared to $20.8 million in the full year 2015. We continue to carefully evaluate our fully with the addition of RSG, for 2017 we except CapEx to be approximately 1% of sales. Net cash used for investment remained in $1 billion for the 2016 year, we did not close any additional acquisitions during the fourth quarter. The year’s amount included the acquisition of these eight stage companies.

As shown in Slide 10, we continue to steadily improve our net debt leverage ratio throughout 2016. After beginning the year, at 4.3 times that’s pro-forma numbers of the RSG acquisition. We ended 2016 at 3.3 times. We remain on track to meet our commitment of reducing our leverage to under 2 times during the next two years.

To conclude my portion of our prepared remarks, I want to spend some time on two remaining items. First, our plan go forward supplemental adjusted EPS disclosures, and second a review of our initial 2017 expectations. During the past several months, we spent a significant amount of time studying the approaches of different companies regarding their use of non-GAAP numbers, specifically the treatment of intangible amortization.

For fiscal 2017, we have elected to again provide non-GAAP supplemental information excluding the RSG related amortization step up. However, we anticipate eliminating the supplemental non-GAAP disclosures when we enter the 2018 fiscal year and beyond. At that point we expect the RSG related amortization patterns to be more consistent for analysts and investors.

We will also begin this year to spend more time discussing EBITDA as a key metric for us. As a highly acquisitive company, we believe this measure provides a great indicator of overall operating performance. Given the ongoing transition in our supplemental materials, we will be providing specific revenue and EBITDA guidance ranges for fiscal year 2017. We are also providing color in other line items, so that you’ll have a clear understanding of the impacts of these on the analyst earnings forecast for Beacon.

As a reminder, the RSG 2016 amortization amount excluded from our non-GAAP disclosures was $22.6 million. For 2017, the excluded amount will be slightly higher at $32 million, all based on the accelerated amount of memorization that we traditionally use of all acquisitions. For further perspective, company line amortization was $68.3 million in 2016 and we expect this to be $79.4 million in 2017. With a year-to-year increase tied to the combination of a full run rate from the 2016 acquisitions and before mentioned RSG amortization increase.

Finally, spending a little bit more time walking to our initial expectations for 2017, Paul mentioned we’re targeting revenue growth of 3% to 7% for 2017, which assumes 2% to 5% organic growth and approximately 1% to 2% from our 2016 acquisitions. It’s also important to know that there are two less selling days in 2017, which will have a negative impact of almost 1% on the year.

We expect EBITDA to be in the range of $365 million to $395 million or 8.6% to 8.9% of revenue. And improvement of 5% to 15% over the current year and represents another company record. We’re hopeful that this expanded guidance, commentary is beneficial. We’ll provide even more detail at our upcoming Investor Day in New York City on December 14.

We’ll now respond to any questions you may have.

Question-and-Answer Session


[Operator Instructions] Our first question is from the line of Keith Hughes with SunTrust. Please go ahead.

Keith Hughes

Thank you. Based on what you said for October, it sounds like the commercial business, is still seeing same trends that we saw in the reported period. Can you give us any more detail on what you’re saying – what we can? How long do you think this will last?

Paul Isabella

Yes, we’ve seen similar quarters in the past. Again this is one month obviously tacked on to the quarter. I mean there is a lot of reasons; we know for sure and we talked about it a bit back after the second quarter call. But there was pull forward at that time very difficult to measure, again that’s why I mentioned the 25% organic growth we saw during the quarter that’s obviously unusual for us and it’s just means contractors get on roofs.

I think some of that is continuing. I think the other thing we’re seeing it is by region whether it’s South, East or in the West some large jobs that didn’t repeat, some of those were lower margin jobs, which I think in some total help our gross margin as we go through time. I’m not at all concerned about our commercial growth. Of course we’re working very hard to counter that, but again as I said we balance that with gross margin gain and our need to continue to keep that where it is in the range we talked about and to grow the other pieces of our business too. So I would think as there is – it is difficult to tell what’s going to happen as we go through these next four months, just because we can’t telegraph, how the winter is going to be and that’s why I said we’re just going to have to go through each quarter, we’ll continue to give you the guidance as we see it.

And of course we’ll report the results. We do know as I said we had a very mild winter last year. And that could affect sales as we go through Q2, but then again it might not. So I think it’s a question of what we see strong first half. And maybe not a strong second half like this past year or the opposite as we go through this year. But we’re not concerned at all. We are pleased with the strong residential growth and complementary I believe is going to continue to rebound as we go through 2017. That’s why it’s important for all of us to look at 2017.

Keith Hughes

Okay. And then the guidance you gave for 2017 in terms of the organic growth number. Can you give us just sort of the feel among the three segments, which of those would be above or below that 2% to 5% you talked about on the organic.

Paul Isabella

Yes. I think without getting into too much detail and I certainly can hand it over to Joe, my belief is that residential will continue to outperform just because we still have the tail end of some of the storm repair work that we started in the April-May timeframe that will go through, again that’s very difficult to tell, but it could go through April or so of next year.

And then the balance of the year for res could be a little softer, we’ll just have to see what the new storms and then the rest of all the indicators with existing home sales, et cetera, bring in general re-roof patterns. But I would think with some normal storm volume like there was this year, we would see res potentially be strong as we go through the year. But again, we’re going to have to give you a tighter guidance as we get through the next three months as we have more visibility to exactly what we’re seeing.

Keith Hughes

Okay. Final question Joe, on the $365 million to $395 million of EBITDA, what D&A is assumed in that number?

Joe Nowicki

Hey, Keith, so the A numbers I would have given you, so those are the ones that I talked about in the end of my discussion there. So the amortization for 2017 expected to be somewhere around $80 million, and the depreciation number will be similar to what this year’s depreciation number as well too.

Keith Hughes

That $20 million I guess.

Joe Nowicki

I’m looking that up right now even as we speak; I think –I may have to find that direct number on the depreciation for you next year. So I’ll get you a specific number on the depreciation one Keith and get back on that.

Keith Hughes

Yes. All right, thank you.

Joe Nowicki

You bet.


And our next question is from the line of Kathryn Thompson from Thompson Research. Please go ahead.

Kathryn Thompson

Hi, thank you for taking my questions today. One thing, not that we can shake the most recent presidential election, but the one thing that is fairly clear from our policy research is that a top priority for President-elect Trump is to lower corporate tax rates, while he is focusing on 15% house is focusing on 20%, it’ll likely end up just north of that, but either way it paints an interesting picture for potential lower tax rate. Two part question for you. One, how would you think – how does the lower tax rate impact you given that your cash tax rate is actually pretty low this year given your heavy use of NOLs.

And then just theoretically how would a lower structural tax rate impact how you think about capital allocation in other words would that extra cash flow be more for growth or would you consider share buybacks or possible one-time dividend. Thank you.

Paul Isabella

I can answer a bit on two, if it we’re again, we’re talking about things we don’t know will still happen or not, certainly we’re going to pay keen attention to that, but on the – what would we do with the cash I think there’s probably a lower probability of right now anyway of dividend and buybacks. We would be much more interested in using that for growth primarily given that we want to continue to help consolidation within the industry. We believe that profitable growth as we have done and demonstrated this past year is a key to our success long-term.

Joe Nowicki

I’ll follow-up just a little bit more, as Paul said I think it’s difficult to speculate on what might happen, but certainly lower tax rates being our advantages to us, right, we’re a high tax payers, 40% tax rate, we’re pretty much the top. So lower tax rates would certainly kind of help us all together. Think about it and certainly it would drive additional kind of cash flow to us. So I think this would strengthen our plan to as Paul said continue our growth options, but also continue our plan to pay down some of our debt as well too. So it would be good news kind of all around. But as Paul said tough to speculate on it. I think it would help us obviously from a cash generation perspective.


[Operator Instructions] And our next question is from the line of Phil Ng with Jefferies. Please go ahead.

Phil Ng

Hi, guys. Joe really appreciate the color on EBITDA and some of the noise around amortization. Can you kind of help us frame how we should think about the front half versus back half? Certainly back half of the year is usually a bigger year, but there’s some noise in the first half due to mild winter, some storm activity and how should we think about synergies that you laid out for [‘17] [ph] kind of flowing through over the course of the year?

Paul Isabella

Yes. I’ll just comment on the first half, second half. It’s – as you can imagine, it’s extremely difficult to predict and all I can say is that it really depends on what’s going to happen for instance through December. We already saw a little bit harsh weather, but it’s in the Northern regions and not necessarily where it’s impacting us. And then what’s going to happen in Jan through March. Obviously if it’s as last year, then we could have a consistent year again.

But then the factor of what happens with storm repair kicks in in the April, May - March, April, May time period in terms of counteracting what happened down in Texas this past year. So it’s very difficult to say. I think the scenario paints the picture of this. If it’s a harsher winter this year, which I think longer-term of course is good for the industry because it also has the same impact that hail does on many of the roofs putting stress on it, then you’d see first half that was obviously with the difficult comps lower than last year. And then you’d see more than likely a back end that was much more positive. That’s why we try to pull back and focus on the total year picture given the variability within these quarters.

And again that’s not a – certainly it’s not an excuse, it’s just pointing to the reality of winter and what happens within these quarters based on whether things we can’t predict and of course we still encourage our folks to go get as many orders and to push as hard as they can regardless of what’s happening outside, but then there is a reality of contractors getting on roofs.

Joe Nowicki

Yes. The two other pieces I would add you – asked about the synergies element right. Synergies they’re pretty much pacing at their full year run rate right now. So that $55 million just divided by four that will give you a good idea the quarterly synergies on top of that, I mentioned we have three to five additional branch consolidations we’re looking at. Each of those branches get to somewhere around a $0.5 million of operating cost improvement when you do a consolidation it varies. But that’s a good approximation. Assume those if they occurred would likely be towards the second half of the year not the first half of the year.


And our next question…

Joe Nowicki

Just a one follow-up note hey Mr. Keith Hughes kind of listening out there, it would be depreciation number to give you an estimate of that, it’s roughly between $30 million and $35 million as what the depreciation number will be next year.

Paul Isabella

Hey Carmen, go ahead.


Thank you. And our next question is from the line of Jason Marcus with JPMorgan. Please go ahead.

Jason Marcus

Hi, good afternoon. So my questions around the gross margin obviously you had a pretty nice improvement in the quarter and given that most of it was really mix driven. I wanted to get a sense as to – as you look across different segment, what are the improvement that you see on residential versus commercial versus complementary. And then as you sit here today and thinking about 1Q, I’m noting then residential to continue to improve at a better rate. How should we think about the gross margins as we go through 2017?

Joe Nowicki

Yes. So first thing just to correct, really the gross margin improvement was very little from mix. It was really more driven by cost improvement. So if you look at the breakdown as I mentioned in my call of what kind of – as I mentioned in my comments of what drove it, it was the biggest factor contributing factor I had to do the cost improvement pieces.

So if you look at it by various kind of segments to it, and break it down between residential and commercial and complimentary. On the residential side, I think as we talked about you saw great kind of – you saw the price declines more than offset about the cost declines as well too, 400 points to 500 points cost improvements there. The price in the residential was at 1.5 points to 2 points. Commercial, so we talked about again they were also on the price and they have 1.5 point to 2 point decline and the cost down between 200 and 300 basis points. In complimentary, pretty much the price and cost piece offset each other there quite a bit. And that drives the breakdown between our key elements.

Your second part of your question was kind of focusing on 2017 at the – yes, so stay tuned. We’re look forward to seniority investor conference coming up on December 14 in New York, we will go through that a lot more detail. But overall, we’d expect to see some slight improvement in gross margins as we go forward into next year.


And our next question comes from the line of Ken Zener with KeyBanc. Please go ahead.

Ken Zener

Good evening, gentlemen.

Paul Isabella

Hi, Ken.

Ken Zener

So this year ended up obviously very well in terms of a RSG acquisition, you continue to gain share and those you highlighted, your head of your synergies, right, if think moving there, but largely procurement that we saw that in this quarter with costs following more than the price you gave up. Given how tough the weather, concerns around weather the comps. Paul you sounded very constructive about residential being positive due to the tailwind I believe you said of the storm slowing through. Does that kind of indicate I mean and pricings that sequentially.

So my question is this, did you think residential will comp negative, despite the strength we had last year on weather and if prices move in positive is that kind of mean your gross margins in that res will be improving kind of steady us – improving through the years kind of get a read on this two metrics given that how seasonal business with last year. Thank you very much.

Paul Isabella

Yes. Thanks, Ken. Well, again it’s difficult as I said earlier it’s very difficult to predict what’s going to happen over the next – let’s call it four months the December through March period. I think if things are mild will comp very well, because again we have some tailwinds at least right now as I said going into April, May. At the same time some good indicators as we look at some of the manufacture reported data. And we have to wait until the end of the year to get the full view of what’s been reported on the residential side related to single square volume, but it appears re-roof has taken a nice tick up especially if we end that 125 million to 130 million squares for the year, and 10 or so, let’s say, our storm that denotes three new construction and re-roofs some decent growth that we haven’t seen in 2014 and 2015.

So that could also aid in one just demand being stronger to us continuing hopefully, again it’s difficult to predict, but we see a good trend with sequential pricing improving especially residentially. But again, I think that the wildcard here is what’s going to happen exactly in the winter. Because if winter is difficult like it was three or four years ago competition gets more heated up, then it’s difficult to say what’s going to happen.


And our next question comes from the line of David Manthey with Baird. Please go ahead.

David Manthey

Thank you. Hi guys, good evening.

Paul Isabella

Hi, David.

David Manthey

I’ll try to squeeze two in here at once, I don’t get cut off. First half, Joe, I was wondering you mentioned the days in fiscal 2017, could you give us how that flows by quarter. And then second more general question you mentioned potential sale synergies between RSG and Beacon. I wonder if you give us some examples of what that potentially might look like in terms of what those would be not the amount.

Paul Isabella

Dave, I’ll consider this A and B question, so it’s still one and I’ll answer B first. On the sales synergies, the comment was intended to really that what we’re doing on the complementary side, we had good growth through the years. Again, I think the market will improve the remodeling index is positive. And at the same time we’ve launched complimentary sales the RSG outside sales folks utilizing current Beacon branches within those metroplex areas to push that product.

And it’s certainly added in 2016 small albeit and I think it’s just going to be another aspect of our growth in 2017, but it will be small, it’s something that we’re working on. And it really – I wouldn’t say its material that it will continue to grow and as we get in the out years, it will turn into something much more substantial. I’ll let Joe talk about the days for 2017.

Joe Nowicki

Paul usually memorizes the accounting calendar, but I’ll give you that one anyway. The days for 2017, Q1 will be 61 days. In 2016, it was 62, so we’re losing a day in the first quarter. Second quarter same 64 as the prior year, third quarter same 64 as the prior year, and fourth quarter 63 days versus 64 days in Q4. So we lose a day in the fourth quarter as well too. So total 252 days, 2016 was 254, hope that helps.


And our next question comes from the line of Garik Shmois with Longbow Research. Please go ahead.

Garik Shmois

Hi, thanks. Just I have a question, if we’re thinking about residential sales and that continues to outpace into fiscal 2017, given the trends that you’re seeing thus far. Just wondering how we should think about operating expense leverage in 2017. I have some – I guess good problem to face here in the fourth quarter because of the stronger residential growth, but does carry I guess a negative mix report on the leverage side. Should that continue into 2017 and how should we think about that?

Joe Nowicki

That’s a great question. And if you look at the full year of 2016 numbers, right, when you consider that mix shift – for a full year that mix shift, right, residential was up about 2% or so over the prior year, that – and the fact that our operating costs as we’ve described before, our operating cost like our margins are almost a 1000 basis points kind of higher on residential business versus the commercial business that would say that for the 2016 number drove about a 20 basis points change.

As you know we try to get roughly 60% variable cost structure in place of 40% fixed. If you do all the math on that and you take into consideration that mix shift in the business, we get to write the spot that we had wanted to so. We actually demonstrated for the full year roughly that same 60% variable cost structure as we had described. Going forward to next year in 2017, same intent, same plan, difficult to do quarter-by-quarter, there’s too many things that impacted like they did in the fourth quarter and others. But on a full year basis, our intent is to gain target that same 60% variable structure, hope that helps.

Paul Isabella

Yes. And the reality is of course we’re going to continue to push all three of our lines of business. Right now we have a little bit of tailwind on resi. I am sure commercial and complimentary we’re going to bounce back, we’re going to put as much energy on those two product lines as we have in the past. So commercial ends up growing throughout of course 2017 greater than residential at the end of the year, so be it. ROI is very similar and the same for growth and complimentary.


And our next question is from the line of Ryan Merkel with William Blair. Please go ahead.

Ryan Merkel

Hey, guys, I’ll ask an A and a B question too if I could fit it in. So A, it sounds like pull forward demand was still an issue in October and I’m wondering when do you think you move past the pull forward and we get back into the mid-single digit organic growth territory. And then second question what is your view for potential inflation next year. It sounds to me like you’re not expecting a whole lot.

Paul Isabella

Yes. I will start with the pull forward, Ryan. Again I think a lot of it, this is third or fourth time, maybe fifth time I mentioned a lot of it depends on what we see in terms of weather in our face in December, Jan, Feb, March, right, because as that occurs, you’re going to be – sales will be impacted as it naturally are. But then you’re also creating more volume as you break through whether it’s March or April.

So it’s very, very difficult to say. I think there are also in addition to the things I talked about some of the large shops not repeating in the pull forward, there was some delay in public funding in some regions that we know is also going to come up because the work has to be done, we know the nature of re-roof. I think this is just a cycle will go through whether at last in November, December. It’s difficult to predict, which certainly are very active with their outside sales folks going after work.

And I expect that will be successful as we do that. I think again the thing that would potentially impact that is just what happens with snow and ice in December through March. And then Joe I don’t know if you want to comment on what the inflation, I mean I certainly can’t.

Joe Nowicki

No, our assumption you’re right, that we don’t – we’re not anticipating any significant impact of inflation in the estimates that we are talking about earlier.

Paul Isabella

And as we’ve looked at whether it’s – let’s say asphalt pricing we’re not concerned at all at somewhat bottom and even if there is still some short supply. So even if it increase, it wouldn’t be concerning for us at all. Manufacturers have picked up pressure, but do what they normally do and they would I’m assuming would attempt to pass price on to us and then hopefully we could pass it on that were the case, right.


And ladies and gentlemen, this concludes the question session. Now, I will like to turn the call back over to Mr. Isabella for his closing comments.

Paul Isabella

Great. Thanks, Carmen. Great questions. Let me close it down. Here is some of the highlights from the call. Some repeats, full year was outstanding at all respects. Sales, gross margin enhancement, debt ratio reduction and acquisition integration were executed extremely well. Fourth quarter sales as we talked about were close to $1.2 billion, up over 49% from the prior year attributed to the acquired RSG branches, the benefit of storm repair, in same-store in greenfield growth.

As Joe talked through our balance sheet is healthy will allow us to deliver in our near and long-term growth goals. We’ve made good progress on our debt leverage and end of the year at 3.3 times. And we’re on our way to achieving our overall goal of 2 times at fiscal 2018. Total revenue for the year was in the $4.1 billion range, this is a record and a great accomplishment for the Beacon team. This is a strong 64% growth over the prior year. As I’ve said many times before, we’re in a great market that will continue to see growth. We’re well positioned to capitalize on this growth with our enhanced branch count, product placement and density in many markets. We are executing on the elements of our strategic plan and we’ll continue to focus on our customers, employees, investors and our financial results.

I also want to give a huge thank you to all of Beacon employees of Beacon legacy and acquired employees who work countless extra hours in extremely dedicated fashion to make the RSG and other acquisitions a great success. Related specifically to RSG, we were able to take two very large organizations and effectively combined them to form a much stronger company as you can see from the results. The legacy RSG team has been and continues to be outstanding. We are very fortunate that their culture, hard work, team spirit and intense customer focus is now part of the total company.

We are proud. We are now one team. And as always I want to thank all of our investors for their interest in our company as well as our customers and all of our employees for their loyalty. This concludes our earnings call. Have a great night.


Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program and you may all disconnect.

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