Beacon Roofing Supply Inc (BECN) 2014 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Beacon Roofing Supply's FY14 first quarter conference call.

My name is Marquita, 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.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes.

This call will contain forward-looking statements that 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.

Bear in mind that such statements are only predictions and actual results may differ materially as a result of risks and uncertainties that pertain to our business. These risks are highlighted in our quarterly and annual SEC filings.

The forward-looking statements contained in this call are based on information as of today, February 7, 2014; 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 these non-GAAP measures is set forth in today's press release.

On this call, Beacon Roofing Supply may make forward-looking statements, including statements about its plans and objectives and future economic performance.

Forward-looking statements are subject to a number of risks and uncertainties. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors including, but not limited to, those that set forth in the risk factor section of the Company's latest Form 10-K.

The Company has posted a summary financial slide presentation on the Investor 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 Mr. 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.

Thank you.

Good morning, and welcome to our first-quarter call.

We begin the year by reporting another record sales quarter with revenue of $552 million.

The quarter started off with strong sales in October and was impacted by harsh weather in November and December. Despite that, we still ended the strong 7.5% total growth in the quarter year over year.

Diluted earnings per share for the quarter ended at $0.30, versus $0.37 in the prior year. This was below our internal expectations. But given the weather conditions and pricing pressure, we feel good about the start of the year.

Given the nature of our business, there will always be fluctuations in sales and EPS due to factors, such as demand in our markets and weather conditions. Our focus is, and always has been, on our full-year financial outlook and achieving our long-term strategic growth objectives as we work to achieve our monthly and quarterly goals.

Q1 gross margin ended at 23%, versus 24.7% in 2013. It was also fairly consistent with the 23.1% delivered in Q4.

While we see the overall market growing for the full year and are optimistic about future price increases, we did see price down slightly in the quarter, which impacted gross margins. In addition, we saw an increase in the mix of commercial and complementary business this quarter, which had a slight negative impact on margins.

In the near-term, we are working closely with our vendors and are planning spring price increases. We are pleased with the level of cost control exhibited during the quarter. Operating costs within our existing markets ended below 18% of sales and below last year's rate.

Cost grew 1.1% versus organic sales growth of 3.3% in the quarter. Good leverage and good performance, especially considering that approximately 2% of the 3.3% organic sales was driven by new branches which typically have higher costs during the start up period.

I'll give you a little more color on growth. As I said, from an organic standpoint, we grew sales by 3.3% in the quarter. We began with 11% organic growth in October. It slowed down to 1% in November as the weather started to kick in, and then due to the harsh weather, dropped off to a minus 3% decline in December. These are all on a same-days basis.

From a strategic standpoint, we continued to pursue growth opportunities from acquisitions and greenfield branch openings. In Q1, we opened four new greenfield locations and are now targeting approximately 25 new branches for the full year based on the progress we have made to date.

I will continue to give updates on this during the year. These new branches should add 2% to 3% organic growth for the year.

For 2015 and beyond, we are planning approximately 20 new openings per year minimum. In terms of acquisitions, I will emphasize again this quarter that we're still very active in the market.

We continue to talk to numerous companies. It's still very difficult to predict when owners will sell, but our intent has not diminished. This has been and will be a vital part of our growth story.

As in past years, we're in a period of less activity. That is not unusual. The greenfield branch push will help offset these normally-occurring slower periods of acquired growth.

Growth in our complementary business was up 7.6% in total, and 1% in existing markets on a same-days basis. We should see this business continue to grow as new construction and remodeling activity gains more strength. We saw solid growth of our commercial business this quarter, at 11% in total, 6.6% in existing markets on a same-days basis.

Now a little bit of information on current market conditions.

As mentioned, both in the press release and my comments, we're in a challenging pricing environment which has impacted gross margins. Demand is a big piece of that.

I mentioned earlier that selling prices were down slightly in the quarter. We don't believe this is indicative of the year to come.

Most manufacturers have announced price increases in the 5% to 7% range to take effect in the April timeframe. There is more optimism this year about distribution being able to pass these along.

In addition, we recently announced a separate and additional price increase to offset cost pressure we are encountering on items such as insurance and benefits.

We announced that this would take effect at the beginning of March and be in the 5% to 8% range. We are in the planning process now and will work hard to get these into the market.

A deeper dive into growth shows some bright spots by region.

We had three of our reported regions grow over 10%, two of them over 14%. However, on the minus side, due mainly to weather early onset, Canada region was down 8.2%; the Mid-Atlantic, down 2.6%; the Northeast slightly down, 1.6%; and Southwest slightly down, 1.4%.

It is noteworthy that industry data shows residential shingle-square shipments into distribution down 6% for the entire 2013 calendar year. We performed better than this in 2013 full year and Q1 of 2014.

And now an update on our outlook for 2014. As we forecast the full year, we still see organic sales growth in the 5% to 10% range. This is in line with current industry productions of around 6%.

As you can imagine, from a sales perspective, this past January that we just finished was down over the prior year because of extreme weather in many parts of the country. On a same-days basis, sales were down approximately 13%.

Given the impact weather plays on our Q2 sales, this is not concerning. Later in Q2 or early Q3, sales should be stronger because of this.

Even in this challenging gross margin environment, we believe margin will be in the 23% to 24% range for the full year. While Q2 will continue to be difficult, we are optimistic about the second half of the year. Price attainment, as you can imagine, will be key during this time; and we're focused on this.

As I said, we were able to control cost in Q. As we grow our business, we will continue to focus on this.

We will, however, be investing in new branches, which will have a slight impact on our cost of sales performance. This investment, though, will pay off quickly as new branches grow to maturity over the next few years.

For the full year, we see operating income in our stated range of 6% to 8%, and our estimate of EPS for the full year has not changed from the last call. We believe we'll be in a lower portion of the current analyst range. That range is now $1.67 to $1.94. Price increase realization, storm volume, and overall market health will impact this number.

And now I'll turn the call over to Joe, who will give you a little more detail on the financials; and then we'll take your questions.

Joe?

Thanks, Paul; and good morning, everyone.

Now I'll highlight a little more detail on are a few key financial results and metrics that are contained in our earnings press release and also the first-quarter slides that were posted to our website this morning.

Total sales for the quarter increased 7.5% for the first quarter record of $552 million. $21.6 million of that growth was from prior acquisitions.

Our FY14 first-quarter organic sales increased by 3.3%. By product group, the increase was as follows.

Residential roofing sales, up 1.4%; Non-residential roofing, up 6.6%; and Complementary product sales, up 1%. Complementary sales trends continue to be encouraging as it further expands on our product diversification.

For comparison purposes, there were the same number of days in Q1 2013 as in Q1 of 2014, 52 days. Sales were steady, despite an overall colder and wetter quarter. We started out very strong in October, but weather had a significant impact in November and December.

In our geographic regions, as Paul described, our Southeast region achieved the highest organic sales growth of almost 21%, while our Midwest region also had an increase of over 12%; and in the West, we saw almost 15% organic growth.

As in our prior quarter, our biggest challenge this quarter was gross margin which decreased to 23% from 24.7% last year. This drove the majority of the unfavorable impact on our year-over-year financial performance.

The lower gross margins this quarter are due primarily to an increase in the net product cost of our residential roofing sales, combined with a slight decrease in our selling prices. Overall, average selling prices in comparison to last year's Q4 were down slightly, less than 1%, due to a challenging pricing environment. The declines were across all lines of business.

Existing market operating expenses, which are shown in slide 2, were up just over a $1 million, but decreased to 17.7% of sales from 18.1% in the prior year. This demonstrates our continued focus on cost control and the leverage we get from the incremental volume.

Overall, payroll and benefits increased to handle the additional volume and also as a result of the greenfields, but were partially offset by bad debt expense reduction and lower overall G&A costs. Our improvements once again in bad debt expense reflect the improved credit and collection processes that are driving a better aging and quality of our accounts receivable.

Overall operating expenses for the quarter as a percentage of net sales decreased to 18.1% from 18.4%, mostly due to the leverage from the higher sales offset, as I mentioned, by some of the increased cost from the greenfields and past acquisitions. The acquisitions, by the way, result in higher purchase accounting amortization, which was approximately $3.6 million this quarter and also drove some slightly higher integration costs.

Interest expense and other financing costs were up $500,000 in the first quarter, mainly due to the FX impact of our Canadian operations. Our effective tax rate was 38.8% for the current quarter, as compared to 40% last year. This was primarily from the lower Canadian income tax rate.

Our net income, $15 million for the quarter, compared to net income of $18.2 million last year. Diluted net income per share of $0.30, compared to $0.37 for the same period last year.

Our adjusted EBITDA, or earnings before interest, taxes, depreciation, and amortization adjusted for stock -based compensation, was $37.5 million, 6.8% of sales, for the first quarter of 2014, as compared to $41.8 million, or 8.1% of sales, in Q1 of 2013.

Regarding the status of our balance sheet, as slide number 4 shows, cash flow from operations was again a very strong $54.2 million compared to $47.3 million last year. Capital expenditures in Q1 2014 were $5.4 million, compared to $3.1 million in Q1 2013.

We still expect capital expenditures to be approximately 1% to 1.5% of sales for the full year, mostly as a result of continued fleet upgrades and the additional greenfield investments.

There was no net cash used for acquisitions; it was $64.5 million last year. Net cash used by financing activities was $39.9 million this year.

Our current ratio was at 2.4 to 1.0, versus 2.0 to 1.0 in Q1 of 2013. The results of our two bank financial covenants at the end of this year were as follows: our leverage ratio, our leverage ratio, 1.4, 2 to 1, compared to 1.55s. And our interest coverage ratio, 16.73, 1 to 1, compared to 14.9, 2 to 1.

The improvement in strength in both of these metrics demonstrates our balance sheet and provides us with the capability to continue to execute on our growth strategy of new branch openings and acquisitions.

We'll now respond to any questions that you may have.

(Operator Instructions)

David Manthey, Robert W. Baird.

Hello, good morning, guys.

Morning, David.

First off, Paul, when you talk about the October, November, December daily sales growth numbers, and then that adding up to 3.3%, by my math that would only work if each of those months were equally represented across the quarter. And I guess I'm under the impression that October would be a better month for you than December in any quarter.

So could you tell us what percentage of the quarter are represented by October, November, December just to get an idea of the waiting?

I don't have the sales, Dave, in front of me by month. I mean, we did the math and we know it's correct. And the big weight of course was, Joe's looking it up, the big weight was the 11% gain we had in October, and that as least positive in November. December dropped off quite a bit.

But December was only minus 3% you said, right?

Yes.

Okay, I guess we'll have to talk about that offline.

I don't have the numbers in front of me. If we get them as we go through the call, we can shout them out. Joe just kind of pulls them.

All right.

Yes. So the sales for the month in October were around $220 million, and in November $170 million, and in December around, looks like $127 million. That gets you close to -- and again, this is existing market sales which gets you close to that $520 million which is existing market sales mark.

Okay. I'll have to work the numbers, but I don't think that those numbers make sense relative to the 11%, 1%, and minus 3% summing to 3%. Just if you weight them by these revenues you just gave me, it would seem like the revenue in the December month would've had to be much, much more down than 3%, but we can take that offline I guess.

I'll be happy to work through you, David.

Okay, great. Second question, on the price increases, the shingle price increases from the manufacturers and that will have its own track, but I'm wondering about the 5% to 8% price increase you are doing unilaterally? You said relative to some of the costs that you have that you're trying to offset, definitely it's good that you're showing price leadership here.

How confident are you? I mean, in an environment where shingle prices alone have been hard to pass-through for the channel, how confident are you you can get 5% to 8% unilaterally just showing price leadership in the market?

I'm confident, Dave. There have been other distributors, large distributors, that have also announced similar increases, non-direct material related. So I think all of distribution saw input costs go up last year.

It seems to me they all felt, we all felt the pain of that on the P&L. I don't have any direct evidence of that other than what I hear in the marketplace.

And so I have confidence that this year there's going to be much less reluctance to give up on pushing both the manufacturer, direct material price increase that's coming down the pipe, for the most part, in mid-April, and then the March increases. Typically, as you announce a price increase, whether it's now or a month ago for let's say a March 1 launch, there is typically a number of weeks before any of it would get out into the market, so it's difficult for us to calculate what that impact is on the full year.

But we're going full bore with a pressure to recoup the cost, not just from what we're going to see in 2014, but of course what we saw Q3, Q4, and then of course the Q1 numbers.

Great, thanks a lot, Paul.

Hey, Dave, by the way, I do have the answer to your specific question on the math. When we do these calculations, it's also the adjusted for the number of exact days in a month, right? So not only is it for the months, but it's also adjusted for the days in the month as well, too.

And we had a difference in days. Even though for the quarter it was the same, it varied the days for each of the month. So the weighting slightly different, that's probably what you're not getting right in the math. But I can walk you through the exact days per month offline and get you to the calculation.

Great, thanks a lot.

All right. Thanks, Dave.

Kathryn Thompson, Thompson Research Group.

Hello, thanks for taking my questions today. The first is on pricing. So our understanding in talking to the field that winter, and this is for residential roofing, winter buy programs have been extended which would beg the question or I guess would be helpful if you could give, clarify what you're seeing in terms of trends? And how this could impact the shingle price increase that has been announced for April?

Yes, Kathryn, I can't necessarily define extended this year, really isn't that much different than prior years. I mean, the manufacturers typically come out and announce the increases, which they typically do every year for the spring, and then there's some pre- buying, right? As a result of the fact that prices are going to go up at some point.

Last year we know the issue was not been able to get pricing in a soft market, so we have not seen any difference. The only real difference I guess is that last year, increases were announced in early December and a lot of buying was induced, much more buying than this past year, in the December period. This year, things have been a little more -- they were announced late in the year, the buying really didn't start until maybe a little later in December, but very little, and then into January.

So in terms of an extension of the window is open longer, we're not seeing that. In terms of our view of distribution buying big, one, it's difficult for us to see that anyway, right? Because we can't see in folks' P&L, we are going to do what we typically do every year and be prudent about the kind of money we spend on inventory based on what we think the market is going to do.

So you could see can see us maybe buy a little more inventory than we did last year because we think, we just believe that the markets, very difficult to think that the market is going to be as flat two years in a row, or to think that any kind of normal storm volume won't return. That's the best way I can answer that, Kathryn.

Okay. And maybe clarify what trend you're seeing in pricing for a residential product versus your non-res product? And give a little bit more color on what you're seeing with non-res trends and how that's changed versus a year ago on that?

Yes. I'll start with volume. The volume we saw in Q1 on commercial was very encouraging, so we are and generally encouraged for the full year on the volume side and hence, I have confidence that we will see price.

ISO or insulation price increases were announced, some put into effect in January, others of this March, April. So I think I'm confident that we'll be able to see solid growth commercially for the year and I also believe we'll be able to obtain price.

And color in terms of where you're seeing the volume growth either geographically or end market?

I don't have much data on end markets, but there's no doubt our strength commercially is in the Northeast, parts of the East Coast, and the upper Midwest where we have a big relationship with Carlisle and we also do an awful lot of business with Firestone, right? We were growing also in other regions, but the percentage would be higher, the dollar value would be lower.

And there's no doubt there's more optimism about improved levels of commercial construction also, which are going to help us we believe.

Great, thank you so much.

Okay, Kathryn.

Ryan Merkel, William Blair.

Hello, guys, I want to follow-up on a pricing commentary. So given the actions we've talked about today, what is your price assumption as it relates to the 5% to 10% organic growth guidance?

That's a good question, Ryan. As we talk through it, as I said, it's been very difficult to try to peg a number given last year where we had virtually no price, negative price in Q1. I think to be realistic, we're in the 1% to 2% pricing range.

Because if we thought we were going to get 5% on each of these actions, whether it's -- well the manufacturers will be the keep even, right? But our own price increase is to really recoup all the cost increases we've seen, but a 1% to 2% I think is a reasonable conservative expectation.

Plus keep in mind the timing of when that gets factored into is what also turns it down to the 1% to 2% for the full year, Ryan, because these price increases will come in effect in third quarter and fourth quarter, right? The later part of the year when we'll really see them.

I'm glad you mentioned that because that was going to be my follow-up. If you got 5% for the insurance and benefits increase, and you also got 5% from the OEMs, I was going to try to figure how that would get to 1% to 2%, but your answer there would be that would be a timing thing?

Just trying to anticipate your questions in advance, Ryan. (laughter)

All right. Well --

And remember the manufacture piece is really, for the most part, to stay even with that input cost increase coming, right? Which we weren't able to do and I think most of distribution, as I said, wasn't able to do last year.

Right.

Well let me ask you this, you mentioned other large distributors have announced non-material price increases. Do you have a -- can you share with us what those price increases were? Was it similar to the 5% to 8% that you're going to go out with?

Yes, sir, yes. Right in that range. Which you know, I think that's, at least psychol -- I've been here almost seven years, that's the first time I've seen that and so I'm encouraged. I'm encouraged.

I think it's important for distribution which is an important piece of the whole supply chain, to be very realistic about their P&L, our P&L, and we need to recoup.

Well I'm sure if you a few of them -- (multiple speakers)

Those have been announced, Ryan, they are in the market. They're not speculation on my part. We've seen the documents, so they been announced.

Okay, well I'm sure a few of them are listening to the call, so let's hope that everyone kind of agrees there. I guess the next question is, if you get the 1% to 2% price, wouldn't price cost then be finally positive for you guys? And wouldn't that help push the gross margin up toward the 24% range, or is that really going to be driven by mix?

No, you are spot on. The price, the 1% to 2%, whatever that ends up being, is going to drive that to the upper range of the 23% to 24% that I said, exactly.

Okay, great. Well, I'll let others get on, thanks.

Thanks, Ryan.

Sam Darkatsh, Raymond James.

Morning, Paul, Joe, how are you?

(multiple speakers) Good, Sam, how are you?

I'm doing fine, thank you. I think we're all kind of sniffing at the same tree here. So your inventory levels were up pretty meaningfully on a year-on-year basis, particularly versus your residential sales growth, but I know your inventory is mostly residential or largely residential.

And that's even despite the fact that last year in the December quarter there was much heavier pre-buying. So where do you peg your inventory levels versus where they should be?

And where do you peg the industry inventory levels? And why shouldn't this also potentially adversely affect pricing heading into the spring?

Yes, it's a good question. Industry, I'll start with the one I can't answer real well, industry inventory levels are very difficult to answer, right? Because I can't see it, what folks are doing. The word from a number of different sources, mostly manufacturers, is that the buy is slightly below last year, but again, that is without any data.

If you look at our inventory, we did do a little bit of just the very slight load. $20 million of the number is acquired businesses, so we had about an $18 million increase, which isn't all that unusual given the quarter, given our view that--

6%

-- we thought maybe the November, December time frame was going to be a little better and we wanted to be prepared. We don't see the inventory as an issue, and it isn't a case where we over bought, so we believe we're in really good shape. And actually if we wanted to, we could add inventory if it made sense.

I don't think, Sam, from what I've heard and seen it will have any material, the industry, will have any material impact on pricing. I think demand is going to gate that, and then the constitution of us, let's say, I can't speak for anybody else, to attempt to get price in the market. Whether it's to take the manufacture increase, which I know they are going to pass that down and we should pass it along, and then our increase for the increased costs we've seen in just about every area, right? We're getting continued pressure on.

So I don't think the inventory buy is going to have any impact on price and all. I think it's normally there's that delay we talk about always, 30 to 60 day gap. That's been normal. Last year was abnormal and I think it's because of lack of storm volume, lack of demand in general.

But I think we have a normal market, normal store volume, there will be demand. I think there will be price appreciation. That's our view right now.

And then my follow-up question, the 1% to 2% assumption for realized pricing this year, what's the sensitivity of your gross margin assumption to that realization? Is it one-for-one? Is it less than that? And how should we factor in the sensitivity of pricing to gross margins?

Yes, I don't want to get into too much detail, but if obviously were at 1% or below, we're going to be closer to the 23% and we're going to do everything we can, obviously, to avert that. If we do 1.5%, we're going to be closer to 23.7% or so. And if we do 2%, we're going to be a 24%, 24.2%, something like that.

There's other factors, obviously, in the gross margin makeup. If there's any kind of a mix shift, which could occur, because commercial seems to be fairly strong. And given what we're seeing weatherwise, there is a lot of optimism in cold-weather climates that there's going to be a fairly large spring break out, especially on commercial, not that there wouldn't be residentially, but there's going to be a lot of roofs damaged commercially I think.

Thank you very much, appreciate it.

Okay, Sam.

Michael Rehaut, JPMorgan.

Thanks, good morning, everyone.

Good morning.

The first question I had just goes to your last couple comments there, Paul, about some of the optimism. And just trying to make sure I understand it right, and the fact that you're deriving some of your optimism in terms of being able, in terms of hopefully passing along the manufacture price increases as well as your own.

It seems to be from two factors. One, the fact that in 2013 there was a down year and you are still kind of in the middle of this housing recovery, and as well as stronger commercial demand. And I guess number two, obviously the harsh weather over the last couple of months maybe driving some incremental storm related demand relative to last year.

Is that the right way to -- am I interpreting that right in terms of the source of your optimism?

Yes, I think it's close. It encompasses most of the big ones, housing recovery, commercial construction recovery, storm volume from the things that are going on now, and then if we just have a normal, let's say, storm year related to hail and events like that.

And the other thing, Michael, I think it may be as equally important is my belief, and I know how we feel at Beacon, 2013 was a tough year for us to take not being able to push price through. And I have to believe the majority of distribution feels the same way. And I just think the appetite now to be tougher on getting priced like we normally do every year anyway, I think it's there.

And then of course internally, we don't just sit back, wait for the cash register ring, and then see what the ticket looks like at the end of it. We have an awful lot of process improvement going on internally, I'm not going to get into detail on that, but just an awful lot related to gross margin improvements across all the branches, whether it's pricing, whether it's cost input. So that fuels that optimism.

Great, that's very helpful. I guess second question, just some of your comments on your acquisition focus, and obviously there hasn't been I guess much announced recently. As you see the market over the next couple of years, these are obviously the acquisitions, they can't be controlled. You have timing, you have certain sellers that may be more willing in price.

I mean, would you characterize the recent lull in activity more driven by difference in pricing? Or is it just the process of some of the sellers from a family standpoint or non-financial related factors that underscores your continued confidence that this acquisition focus will continue to be realized at a pace similar to the last two, three years?

Yes, I think there's always going to be of course personal factors within these businesses, right? Because they have to make their decision and they have to be ready, they have to understand they're own succession planning within the family, et cetera.

I do think, one, there's just a normal cycle anyway. We've seen it. If you go back to 2000 or 2004, we've had big years, we've had off years, and we're in a four quarter plus since we did Ford and CMS December last year, right? Where we haven't announced one, doesn't mean our intent, our effort, all that is diminished, as I said, it is still very strong.

I think the other reality is 2013 wasn't the greatest year, so a lot of the distribution didn't put up good numbers. So they're waiting to put up better numbers so, yes, pricing is better in their mind. So pricing is a piece of it, too.

But I also just think there's a normal cycle of when some of these things occur. We're not going to just go out and buy any business, right? So we're selective because if you look at the businesses, for the most part, a large majority of the businesses we purchased are very, very strong businesses in their own right before we purchased them. And that's been our strategy.

So we're somewhat selective and, as I've said before, we're definitely not going to overpay. We're very careful about use of our debt, use of cash. So I think we're just in a little bit of a lull, so at the same time offset that, we're going to continue to focus very hard on the greenfield piece, which we've had very good success with and we'll open, I said, this approximate 25 number.

Last call last, in the last two calls I was talking about 15 to 20. We have confidence we can beat 25. And next year, I've said 20 minimum, but ideally I'd love to do 30 or more because I think we want a national footprint, we believe we should be in more states than we are, and believe we should be in more cities where we even have one branch, bigger cities.

So it's an opportunity for us to provide value for contractors and that's what we're going to keep pushing.

Great, thanks for that answer, appreciate it.

Okay.

(Operator Instructions)

Neil Frohnapple, Longbow Research.

Hello, good morning, guys.

Hello, Neil.

Just a follow-up on the new branch discussion. So the 25 greenfields you're now targeting in this year, you mentioned new branches should add 2% to 3% growth for the full year. So are the openings more first half weighted? Because I thought a new branch on average generates around $2 million sales in year one, so that would imply growth from that would be more like 1% or 2%, so just can you provide any thoughts there?

Yes, when we talk about greenfields, we talk about the same way we calculate acquired markets, that definition we have in the queue of the four quarters of existing business. So there's a few that we launched that are in that number, we launched in Q4 of last year of course because they're still quote green as part of the organic piece.

As we said, we opened four in Q1 so they're going to see to varying degrees full-year sales. There will be, though, a number of them, if you look at them, I'm not going to go to the details of Q2, 3, and 4, but it's somewhat equally placed for those quarters of when they're going to open.

And they'll just be some that are open, obviously Q1 are going to have less sales because of Q2. The Q2 will be pushed down a bit and then pop back up in Q3 and 4 if they're in northern markets, although we have a number opening in southern markets. So we do pro formas on all of these, just like we would analyze an acquired market.

We have an estimate of what their sales are going to be by month as we open them. So as we do the math, that's where we come up with is we're up 2% to 3% for the ones that we open. Pretty much last year fourth quarter, most of those weighted towards the September timeframe because we had a much bigger rush to push them through the back part of the year, and the new ones that will open and it works up to about that 2% to 3% or so.

That will be the difference that Paul was just describing. Remember we did I think there was almost seven of them in the last quarter, the fourth quarter of last year. We had a lot of them that went in during that timeframe.

Those will be with us as part of the greenfield numbers we talk about for this year. So it's not just the 25 that we're opening this year, but it's also the other ones that we opened last year as they go through the year, too.

Yes, as I said, we'll use the same calculation method as we do for acquired markets, just to be consistent.

Great thanks for the color. And maybe be a question for Joe. I believe last quarter you broke down the year over year gross margin decline from mix price and product cost increase, and just wondering if you're able to do that again for the December quarter? And wondering if part of the gross margin decline was due to the increase in mix of direct non-resi product sales and what that contributed as well?

Sure I can give you a high level, Neil, of the gross margin rate. So last year the first quarter, we were at that 24.7% rate. This year we're at 23%. So how do we kind of go from one to the other and then you can do some of the math as well, too.

So the three big pieces to it, as we talked about, one of them the price element, as Paul said, one of them the mix issue, and then one of it some of the cost issues. So on the price part, as Paul said, it was somewhere around 70 to 80 basis points on the gross margin impact, so around $4 million.

The mix impact did have an intimate type to us, but not a lot dollars, about $1 million, so somewhere around 20 basis points.

And then the input cost, as Paul talked about, were somewhere around $5 million impact to us, which was around, somewhere around an 80 basis point number. So that walks you from the 24.7% down to the 23% number. Does that help?

Yes, thank you very much for the detail, appreciate it.

Yes, so mix actually played a less of an impact than in previous quarters. The bigger mix change was on our acquired businesses and you can see that in the GM rate, and that's nothing systemically that's changed.

That's just we're getting into to where Ford is contributing more, which is the acquisition we did in Northern California, they're heavy commercial. And then Western PA, that acquisition, the later acquisition we did, has got a heavier commercial complementary kind of mix which impacts the gross margins there.

And then, Paul, just one clarification. I mean, as you go forward will that cost headwind, that $5 million that you guys saw in the quarter, will that moderate in the March quarter and as we go ahead of the year? How should we be thinking about that?

That's a good question. It should moderate, as best we can calculate. Remember, for the big month we had in October, those sales were inventory we bought three, four, five months earlier, right? And that was in the heat of when we were taking that material in at a higher rate and we couldn't get the price out, right?

So as we go through time, we're burning through and burned through most of that inventory and we're into a different level of inventory in terms of cost wise. So yes, it should moderate, but it's still important for us to get the price that we're talking about to get us to this higher range of the 23% to 24% gross margin.

Great, thank you very much.

Okay, Neal.

Brent Rakers, Wunderlich Securities.

I wanted to follow up on the potential distributor price increase. How is that planned on being implemented? Is it a list price increase to customers? Is it a surcharge?

It's -- we wouldn't typically talk list. It would be current prices we're charging, be a price list at the branch level are going to be increased that range, and that's what were going to be pushing out to the customer base.

Okay. And then if you could maybe comment --

I'm sorry, Brent, if we are charging $1, we're going to charge $1.05 or $1.08.

Okay.

Or go in between, $1.065.

Okay, fair enough. And then if you could maybe talk a bit about, you talked about the January month I think down 13% year over year, what is the typical contribution to the overall March quarter from the January month?

That's a good question. I don't have the percentage in front of me, I don't know if Joe has it. If not, we can follow-up.

I know typically it's one of the lowest months in the year. I don't, Brent, have the percentage in front of me.

Okay, and then I'm sorry, just one last question if you could, it's just a housekeeping question. I know you had some items last year affecting the interest expense line. Could you maybe provide -- the current quarter run rate, is that a good number to use on a per quarter basis for the remainder of the year as well?

Yes, I'll give you a quick break down. So in the interest expense financing charge other category, there's really three items in there. So the interest expense itself was around $2.4 million. We had a loss on FX, again this have to do with the Canadian exchange rate, as you guys know, changed pretty dramatically through the course of the quarter and still is today, that was around a $600,000 impact.

And then we had actually some gain on some the asset sales in there, so of around $300,000. That is what gets that $2.665 million number.

Okay.

And yes, the interest expense number, so the good news as you probably saw from looking at our balance sheet, we were successfully able to minimize, in fact eliminate, so our revolver down to zero at the end of the quarter, and you saw our cash balance grow as well, too. That helped us with a pretty good kind of interest number for the quarter. Okay, great thank you.

And, Brent, a rough number I guess to use, I don't have the exact -- January is probably in the 20% to 25% range at the quarter.

Thanks, Paul.

Okay.

That does conclude the questions. Now I would like to turn the call back over to Mr. Isabella for his closing comments.

Yes, let me just go through a few of the highlights for the quarter in our release. As I said, sales were a record at $552 million. We're pleased with that. Of course, we were shooting for something higher, but that represented 7.5% total growth, and it does demonstrate our ability to execute in a somewhat difficult market conditions.

Organic growth was 3.3%, and 2% of that, as I said, was attributed to the new branches we've opened. We opened up 4 new branches and we're planning on the 25 for the full year. And again, as I said, that should be in the 2% to 3% organic growth.

We're going to continue to be active in the acquisition market. This portion of our growth strategy has always been uneven, but we're still very positive about making additional acquisition.

As Joe said, cash generation was solid in the quarter, at $56 million, above last year. Cost control continues to be something we do very well with existing markets coming in less than last year.

We have a very solid debt ratio, so we're doing a good job at controlling how we're spending money. And lastly, maybe most importantly, we're planning on these two price increases for the spring to offset costs we're seeing.

I want to thank all of our investors for their interest in our Company, as well as our customers, employees for their loyalty. This concludes our earnings call and I'm available for calls here in the Herndon office. Thanks and have a good day.

That does conclude today's conference, we appreciate your participation. You may now disconnect.