Foundation Building Materials. (NYSE:FBM) Q3 2018 Results Earnings Conference Call November 1, 2018 8:30 AM ET
John Moten - Vice President of Investor Relations
Ruben Mendoza - President and Chief Executive Officer
John Gorey - Chief Financial Officer
Keith Hughes - SunTrust
Nishu Sood - Deutsche Bank
Mike Eisen - RBC Capital Markets
Ryan Merkel - William Blair
Chris Shook - Evercore ISI
Marshall Mentz - Barclays
Greetings, and welcome to the Foundation Building Materials Third Quarter Conference Call. [Operator Instructions] It is now my pleasure to introduce your host, John Moten, Vice President of Investor Relations for Foundation Building Materials.
Good morning and thank you for joining us today for our third quarter 2018 conference call. I'm joined by Ruben Mendoza, our President and CEO; and John Gorey, our Chief Financial Officer. In addition to the third quarter press release issued this morning, we have posted a presentation to supplement this call, which can be obtained in the Investor Relations section of our website at fbmsales.com.
Our prepared remarks and answers to your questions this morning may contain forward-looking statements as defined in the Private Securities Litigation Act of 1995. Forward-looking statements address matters that are subject to risks and uncertainties, which may cause actual results to differ from those discussed today. Examples of forward-looking statements include remarks about future expectations, beliefs, estimates and forecasts as well as other statements that are not historical in nature. Forward-looking statements that will be discussed today relate to our acquisition strategy and pipeline, our greenfield expansion strategy, our ability to gain leverage in our business, our ability to increase market share and expand into new markets and our 2018 guidance.
As a reminder, forward looking statements represent management's current estimates. We assume no obligation to update any forward looking statements in the future, unless otherwise required by law or the rules of the New York Stock Exchange.
Listeners are encouraged to review the more detailed discussions included in our filings with the Securities and Exchange Commission regarding the various risks, uncertainties and other factors that could cause actual results to differ materially from those indicated or implied by these forward looking statements.
Additionally, during today's call, we will discuss non-GAAP financial measures, which we believe could be useful in evaluating our financial performance. Other companies may calculate these measures differently, and our presentation of these non-GAAP measures should not be considered in isolation or as a substitute for measures prepared in accordance with generally accounted principles or GAAP.
A discussion of how we calculate adjusted EBITDA, adjusted net income and adjusted earnings per share as well as a reconciliation to the most directly comparable GAAP measures can be found in our earnings release, which has been furnished to the Securities and Exchange Commission and is available on our website. With that, I will now turn the call over to Ruben.
Thanks, John. Good morning and thank you for joining us for a review of our third quarter results and a discussion of recent developments in our business. In September, we announced that we entered into a definitive agreement to sell our Mechanical Insulation segment or our MI segment. As a result, our financial statements reflect this segment as discontinued operations. The reported numbers discussed on this call will focus on the results of continuing operations or the Specialty Building Products business.
For the third quarter, we recorded strong double-digit top line growth with net sales up 16% year-over-year to $542 million, base business net sales up 13% to $472 million and adjusted earnings per share of $0.19. Adjusted earnings per share, including both continuing and discontinued operations would have been $0.26 per share.
During the third quarter, higher product costs in wallboard, suspended ceilings and metal framing resulted in a decrease in gross margin compared to the prior year quarter. In the third quarter, we implemented price increases across our product lines in response to higher product cost, which has resulted in an improvement in gross margin compared to the second quarter of 2018. In the fourth quarter, we expect continued improvement to our gross margin and as our pricing initiatives gain traction in the market.
Now turning to wallboard. Base business net sales increased 8.5% compared to the prior year quarter due to volume growth of 6.4% and a 2.1% higher price. As expected, our wallboard demand increased in the third quarter due to strength from our commercial and residential end markets, and we expect continued year-over-year improvement of wallboard sales in the fourth quarter.
Our suspended ceilings product line recorded base business growth of 8.7% compared to the prior year quarter due to price increases for grid and solid demand for our ceiling and architectural specialty products for the nonresidential repair and remodel market.
As one of the leading distributors of suspended ceilings in North America, we continue to see opportunities to drive market share gains as we grow and expand into new geographic markets.
Metal framing also reported strong results in the third quarter with a base business net sales increasing 33.8% compared to the prior year quarter due to double-digit price increases and high single digit volume growth.
We continue to see solid demand for our metal framing products in the non-residential end market. And we believe the price increases initiated earlier in the year will provide support for gross margin improvement for the balance of the year.
Our complementary and other products also posted solid results with base business net sales increasing 8.5% compared to the prior year quarter.
Complementary products, which includes wallboard accessories, insulation products, tools and fasteners, are an important contributor to the company as we continue to expand the range of products we offer through our branch network.
Our complementary products typically generate higher profit margins than our other product offerings, and we believe there is an opportunity for an additional growth as we expand our geographic footprint.
Turning to acquisitions. We completed the acquisition of Ciesco in the third quarter and recently announced the acquisition of Agan Drywall Supply.
As previously announced, Ciesco is a leading independent distributor of drywall, metal framing, ceiling products, insulation and complementary products, serving five states in the Northeast and the Mid-Atlantic.
In early October, we also announced the acquisition of Agan Drywall Supply, a distributor of drywall, EIFS and stucco, serving three markets in the Great Plains states.
In total, we have completed four acquisitions year-to-date with annualized net sales over $130 million.
Our acquisition pipeline remained strong, and we will continue to make strategic acquisitions to expand our geographic footprint, grow our market share and provide greater product offerings to our customers. We believe that we are the acquirer of choice, and we have a solid pipeline for future acquisitions.
In addition, we continue to open greenfield branch locations that supplement our organic growth. So far in 2018, we have opened 4 greenfield branch locations in Rochester, Minnesota; Las Vegas, Nevada; Boynton Beach, Florida; and New Braunfels, Texas. And we plan to open another one to two locations by the end of the year. Our greenfield branch expansion strategy is designed to leverage our national scale, increase market share and support organic growth.
In late September, we entered into a definitive agreement to sell our Mechanical Insulation segment for $122.5 million, and we expect the sale to close on the fourth quarter of 2018.
The divestiture of the Mechanical Insulation segment will sharpen our focus on our wallboard, suspended ceilings, metal framing and complementary product lines. The sale of the MI segment will also help to improve our long-term profitability.
Additionally, we will use the net proceeds of approximately $116 million to pay down our ABL credit facility, which will reduce our debt.
As we finish the year, we expect continued improvement in our profitability with increase in gross margin for the balance of the year due to pricing initiatives across our portfolio.
Now I'll turn the call over to John for more details on the quarter.
Thank you, Ruben. I would also like to welcome everyone on today's call. As a reminder, our discussion today excludes Mechanical Insulation segment, which is reported as discontinued operations.
As Ruben highlighted, our third quarter results were strong across our business with net sales of $542.3 million, up 15.9% over the prior year period; base business net sales of $472.1 million, up 12.5%; and adjusted EBITDA from continuing operations of $43.7 million; and 8.1% adjusted EBITDA margin.
As a reminder, we define base business as FBM branches that were owned by us since January 1, 2017, and greenfield branches that were opened by us since that date.
Gross profit for the third quarter was $154 million compared to $135.9 million, an increase of $18.2 million or 13.4%.
Gross margin was 28.4% compared to 29% in the prior year quarter. The decrease in gross margin was primarily due to higher product costs.
Selling, general and administrative, or SG&A, expense for the quarter was $113.3 million compared to $102.3 million in the prior year quarter.
SG&A expense as a percentage of net sales improved by 100 basis points to 20.9% compared to 21.9% in the prior year quarter. The improvement in our SG&A leverage is primarily due to higher net sales and our ongoing cost-reduction initiatives.
Over the last year, we have been reducing our SG&A expense through leveraging our economies of scale, consolidating shared services and reducing branch-related overhead costs with the goal of achieving annual improvement in our adjusted EBITDA margin.
Now turning to our balance sheet. We ended the quarter with cash and cash equivalents of $10.6 million and $305.7 million drawn on our ABL credit facility.
In August 2018, we completed the refinancing of our senior secured note, an ABL credit facility that reduced our interest rate on the debt by approximately 200 basis points. The debt refinancing results in a onetime charge of $58.5 million upon the extinguishment of the note, which is reported on the consolidated statement of operations in the third quarter of 2018.
Beginning in the fourth quarter of 2018, we expect $12 million to $15 million of annual cash interest savings due to the refinancing of the notes.
Now turning to financial guidance for the full year of 2018. We expect net sales to be between $2 billion and $2.06 billion. We expect full year 2018 adjusted EBITDA to be between $146 million and $150 million.
Based on current market conditions, we are providing preliminary 2019 guidance of $2.1 billion to $2.25 billion for net sales and $160 million to $180 million in adjusted EBITDA.
Now I'd like to turn the call over to Ruben for some closing remarks.
Thanks, John. We're very pleased with our third quarter results. We delivered double-digit net sales and base business growth, reflecting our balanced product mix and strength in the commercial end markets.
Our business remains strong, and we continue to see solid activity in each of our end markets. FBM has a balanced business portfolio across product categories and end markets with new nonresidential and commercial repair and remodel representing over 70% of our net sales. We continue to see building activity and tenant improvement, data rooms, offices, schools and the health care sector well into 2019.
As we conclude our prepared remarks, let me reiterate our key strategic priorities. First, we will drive organic growth by opening greenfield branches, growing our market share and expanding the number of products we offer our customers.
In 2018, we've opened four greenfield branch locations, and we plan to open one to two more locations in the fourth quarter. Second, we will continue to focus on profit margin expansion across our business by leveraging our economies of scale and executing on our cost out initiatives with the goal of achieving improvement in our adjusted EBITDA margin.
Third, we will optimize our cash flow through debt reduction. As previously discussed, we have recently refinanced our debt and expect $12 million to $15 million of annual cash interest savings beginning in the fourth quarter.
In addition, our plan is to pay down debt to reduce our total net debt leverage to the mid-3s by the end of 2019.
Fourth, we will continue to make strategic acquisitions while being mindful of our debt reduction targets. For 2019, we expect to acquire $100 million in annualized net sales. We believe these actions will drive growth, improve profitability and deliver long-term value to shareholders.
That concludes our remarks. And now we'll be happy to take your questions.
Thank you. [Operator Instructions] Our first question is from Keith Hughes with SunTrust. Please go ahead.
Thank you. There's a lot of controversy, obviously in this space around macro trends. Could you just kind of give us an overview of your different end user markets, how you see business as you end the quarter and trending into October and towards the end of 2018?
Thanks, Keith. Yes. I'm going to pause on your question for a second. There's a couple of things that I want to make sure that I get through before I answer your question. I want to -- our business with discontinued operations was $624 million in sales, and the consensus during that time was $595 million. EBITDA consensus was $47.5 million, and our overall EBITDA was $49.5 million.
So I just want to make sure nothing gets confused with these discontinued operations. Mechanical Insulation sales were over $300 million on an LTM basis, and EBITDA was a little over $20 million on an LTM basis. I just want to make sure that everybody's clear on our discontinued operations. So let me get to your...
Yes. The consensus I had on deck said we had taken it out and didn't take it out is what you're referring to.
That is correct. And I just wanted to make sure, before -- when it was consolidated, those were the numbers. Now it’s kind of changing because you guys are changing your models. But I want to make sure that on this call, I mention that. So overall business is -- our end markets, there's -- 23% of our business is residential. I saw a note that 57% of our business is residential. That's not the case. Our R&R business is probably 80% to 85% commercial, so about 23% of our business is residential.
And we've seen not much of a decline in our residential markets. There’s been, obviously, a few spots where there has been. And I know there’s a big California residential mix, but our California business is strong. And so overall, R&R business, our ceilings business, our metal framing business is -- remained strong. Our October sales -- now there’s one more day in October in 2018 than there was in 2017, but October sales on a same-day basis are up double digits, just like our third quarter.
And our gross margin improvement, like we've mentioned in October, is expanding. We’re 10 to 20 basis points up in gross margin in October over our third quarter. So we're seeing still strong business. Like I said, 34% of our business is R&R. 85% of that is commercial and a lot of nonresidential for us. And we see strong markets in data centers, health care, institutional. We still see it good for – through into 2019.
And referring to the gross margin, you discussed why you were down in the third. It is – if we look at the gross margin versus – or what you’re anticipating in this guidance versus the fourth quarter prior year, is – how close do you think you can get to the prior year number?
It’s going to be very similar to the third quarter. It’s still going to be a separation between last year and this year. And it’s really primarily due just to -- taking us long to get through these higher product costs with all the different price increases we’ve had this year. So it’s still going to remain 40, 50, 60 base -- 40 to 60 basis points, sorry, difference between last year and this year.
What was the gross margin in the fourth quarter of last year, excluding Mechanical Insulation?
It was right at 29% to 30%.
And I guess final question. You did a nice pricing, really, on all the -- most all the products. And wallboard, what -- do you anticipate the same level of increase in the fourth quarter that you saw in the third?
Yes. So Keith, in your initial note that you had our pricing on wallboard up six point something percent, that was actually our volume. It was up 6.4%. Our price was up 2.1%. We do expect that to stay similar in the 2% range for pricing in wallboard.
Okay. All right. Thank you.
Our next question is from Nishu Sood with Deutsche Bank. Please go ahead.
Thank you. I wanted to ask about the 2019 numbers that you’ve put out. Obviously, appreciate the forward look. There’s a lot of concern, and I think you’ve addressed that fairly well. Just wanted to dig into what specifically you’re trying to convey with the numbers. The 7% sales growth at the midpoint that’s implied in that, like how are you thinking about that volume pricing versus greenfield branches?
And then the 30 bps in EBITDA margin expansion, just want to understand the drivers of that. Is it 30 now versus the 50 bps that you'd talked about in prior years just because of the gross margin pressures as most of that is going to come from SG&A? So yes, just I was wondering if you could dig into that 2019 numbers a little bit, please.
So before John gets into the numbers, one of the reasons that we provided fourth quarter and 2019 is we sold a decent amount of our business, 13% of our business and it's being reported as discontinued ops. And we wanted to make sure, I, especially wanted to make sure that we were clear on exactly what we were looking at going forward. And so that's one of the reasons that we are providing this fourth quarter and 2019. As far as the numbers go, I'll let John go on that.
So as far as our 2019, we’re looking at about approximately a 3% volume increase overall as well as about a 2% price increase. And then there's some acquisition revenue in there. We’ve mentioned we are looking at about $100 million of acquired revenue for 2019 and approximately four to sx greenfields.
And Nishu, if you look at the 50 basis points that you asked about, our EBITDA margin for 2017, I believe, is 7.3%. The midpoint for our guidance for 2019 is about 7.75% to 7.8%, so that's 50 basis points right there. And we do still expect to get roughly in line with that by the first half of next year. Like we said, we extended it after the first half of next year. So we still feel like it's in line with that. Some of it will be volume and market share gains, and some of it will be SG&A and gross profit as well.
Got it. Got it. No, that’s helpful. And then thinking about the gross margin trends and the new pricing environment, I mean, clearly, the drag -- the principal drag on the margin expansion has been more competitive pricing environment and obviously, cost increases coming on the wallboard and related materials as well. So now that we've had a little -- I guess, a little over a year in this new environment, as we look back on that, how long would you say is it taking for you to pass price on?
And it looks as though, in your 2019 guidance, you're expecting that environment to continue. But if we get some stabilization of prices or maybe some inflection in prices, would that lead to a gross margin boost? But I guess, I had a couple of questions there, but the main one being how long is it taking you to pass on prices in this current environment?
So, really good question. And so if you look at the years prior, there was one price increase in drywall, and then metal framing may have had a price increase, and ceilings and grid usually had one or two price increases. And everybody knew about them in advance. This year, in 2018, as we mentioned on our last call and before; there have been over four price increases in metal framing, over four or four price increases in grid from Armstrong USG, and there have been 2 price increases in drywall, so the second price increase in drywall was unexpected, and a couple or 3 of those other price increases were unexpected.
So this year, it’s definitely taken longer to get through the channel. As you probably know, a lot of our work is quoted work, its jobs that we quote in advance, so it's just taken longer in 2018. So, on the second part of your question, when there is some stabilization, we will definitely have some stabilization in our gross profit improvement, definitely.
Got it. Got it. Okay, great. Thanks for the details.
Our next question is from Mike Dahl with RBC Capital Markets. Please go ahead.
Good morning. This is Mike Eisen on for Mike Dahl. Just a quick question for you guys following up on those prior comments, and looking at the pricing trends in the quarter, you’ve talked in the past about 30 to 60-day lag until price really takes hold because of inventory. So I was wondering if you could tell us where pricing was as you exited the quarter and how you think inventories look in the channel at this point?
We saw about a 20 basis point improvement sequentially, and we’re seeing somewhere in that 10% to 20% going forward in the fourth quarter. So we're still seeing a positive trend as it did in the end of the third quarter.
And now our inventory levels are at our normal levels. And so we should see some continued gross margin improvement as we move forward.
And then just following up on that theme of some of the disruptions earlier in the year due to competition; is your guys' sense that inventory levels are normalized across the industry? And have you seen any change in the competitive landscape in the market here today?
So I don.t think we made any comments about competitive situations. We -- most of our comments have been on price increases and passing them through. And -- but we have made comments in the past on the competitive landscape, and we have seen some stabilization in that. So yes, we have.
Understood. Appreciate the help.
Our next question is from Ryan Merkel with William Blair. Please go ahead.
Hey, thanks. So I just want to pick on the price cost conversation again. Ruben, have you made progress since June? It’s just hard for me to tell. Maybe just start with that first question.
We have. So, at the end of June, Ryan -- and thanks for the question. At the end of June, we were at a 28% margin. We just reported a 28.4%. And in October, we see about possibly 15 basis point improvement on that. So we are making progress. It is slower than I want, but we are making progress on that. And we’ve had -- we had a great quarter. And we had a lot of business, $624 million in sales on a total basis. So we’re seeing our inventories go through and come down in the fourth quarter. We’re seeing our margins, product margins come up in the fourth quarter, and so we’re definitely seeing an improvement in the trend.
Okay. That’s what I thought. I just wanted to confirm that. And then this is the harder question. But when do you think we might start covering the rising costs? Is that first quarter 2019? Could it take a bit longer? And then, I guess, this would assume that costs don't keep rising. So maybe comment on that. Are you still seeing suppliers send you letters raising prices at this point?
So no price increases that we’ve seen in the fourth quarter in any of our major product categories. And the first price increase that we've seen, at least announcement out for 2019, is not until February. So that will put a little bit of a difference in the January of the previous years. And so when will it get caught up? I do believe in first quarter of 2019 we should see some of that catch up.
Okay. And then just lastly, I know you hit on this, but just back to the new resi again. So is it your view that the slowdown that we’ve seen is more of a pause? You don’t think that the markets are fully recovered? Or are there any markets like California or the coast where you think housing has fully recovered? Or is that not your view?
No, it’s really -- my view is -- I'm combing over Dodge. I'm combing over John Burns. I mean, we're trading in like a recessionary. Our business is trading in a recessionary, it seems, market. And so I'm just combing over the numbers going through. And the best I could see is 2018, 2019 in resi looks like it might be flat to down 1% to 2% in California. And I did mention, we’re 23% residential, so it's less than a quarter of our business residential.
And in California, it’s our biggest footprint, and it’s a good business for us. Our guys and gals here do a great job and -- as well as the rest of our business, but you specifically asked about California. And we see our business very strong, but once again, our business in California is quite commercial, not so much resi. And so I don't know if I answered your question about the pause or not, I do know that 1.3 million housing starts on a total basis with multi-family is probably a low number, and I may be off there a little bit. But I do see us needing -- getting to 30-year averages of 1.4 million, 1.5 million.
Yes. And I think that’s fair. Okay. Thank you.
Our next question is from Trey Morrish with Evercore ISI. Please go ahead.
This is actually Chris Shook, on for Trey. So you called out hurricane cost in your adjustments. Do you expect to see any increase in demand following the storms? And is there any way to quantify that?
No. These current storms really are not in our market area. We don’t have a lot of presence there, so we don’t see any material movement from the hurricane.
All right. And then for your overall 11% organic sales growth, is it possible to break that out between pricing and volume?
Well, in gypsum, we do break it out: 6.4% of our gain was in volume, 2.1% was price. In metal framing, we had a 33.8% increase. We – it’s tough. We measure that in pounds. We were up about high single digits, about 8% in pounds, and the rest was price. In grid and ceilings, we mentioned that a lot of that was price. We feel like our mineral fiber was about flat, and architectural specialties was up. We were pretty much in line with what Armstrong, AWI's, results were in the ceilings part of the business.
All right. Excellent. Thank you very much.
[Operator Instructions] Our next question comes from Matt Bouley with Barclays. Please go ahead.
This is actually Marshall Mentz, on for Matt. Thanks for taking my question. Just wanted to go back to the prior question on competition and specifically around your wallboard volumes, obviously, one of the better organic volume numbers you’ve posted in at least a year. Could you maybe just talk about how that 6.5% number compares to where you think your underlying markets were during the quarter? And maybe just strategically, is there anything different that you're doing to drive that better performance?
Thanks, Marshall. That's a great question. So we gained share in the third quarter. We believe we gained share in the third quarter. And just being perfectly candid with you, we lost share in third quarter of last year and the fourth quarter of last year and possibly the first quarter of this year. Second quarter, I believe we gained a little share. In the third quarter, we gained a fair amount of share. We had that disciplined approach last year, and it was good for us. We kept our margins at a decent level, and we feel like we can continue to get our margins back to where they were with continuing our strategy and gaining some share, but we definitely did feel like we gained some -- the share back that we lost.
Great. That’s good to hear. And then on -- similarly, on the competitive side for M&A, obviously, you had to keep them pretty tied up at least the last month or so with the MI deal. But how does that landscape look in terms of number of deals available and what you’re looking at and maybe how you're balancing that with greenfields?
So good question. So our -- like I mentioned on the call on the prepared remarks, our pipeline is strong. And we have a good team working on that and have a lot of discussions going on. Now having said that, we -- in our prepared remarks also, we talked about $100 million of annualized acquisition revenue. And so we did four acquisitions this year so far, and that’s been $120 million to $130 million of annualized revenues.
So we’re going to be disciplined and selective as we pay our debt down, as we also said in the prepared remarks. But our pipeline remains strong, and we will definitely be selective and -- but we will do some acquisitions going forward. And the competitive landscape of it is we still firmly believe that we're the acquirer of choice. We are -- we're seeing that in the deals that we’re doing. And we feel like we have a competitive advantage there.
That’s all. Really helpful. Thank you.
[Operator Instructions] There are no further questions registered at this time. This concludes the question-and-answer session. I would like to turn the conference back over to the management for any closing remarks. Thank you.
I just like to thank everybody for joining our call and appreciate it, and see you next time.
This concludes today’s conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.