Builders FirstSource Inc (BLDR) 2007 Q2 法說會逐字稿

Welcome to the Builders FirstSource second quarter 2007 earnings conference call. Your host for today's call is Floyd Sherman, Chief Executive Officer. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. Any reproduction of this call in whole or in part is not permitted without prior written authorization of Builders FirstSource. As a reminder, this conference is being recorded today, July 27, 2007.

I would now like to turn the call over to Hala Elsherbini, who will begin the call.

Good morning and thank you for joining us to discuss the second quarter 2007 financial results. We issued a press release after the market closed yesterday. If you don't have a copy, you can find it on our Web site at www.bldr.com.

Before we begin, I would like to remind you that during the course of this conference call, management may make statements concerning the Company's future prospects, business strategies and industry trends. Such statements are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties which could cause actual results to differ materially from expectations.

Please refer to our most recent Form 10-K filed with the Securities and Exchange Commission and other reports filed with the SEC for more information on those risks. The Company undertakes obligation to publicly update or revise any forward-looking statements. We have provided reconciliations of adjusting items and non-GAAP financial measures in our earnings press release and detailed explanations of non-GAAP financial measures in our Form 8-K filed yesterday, both of which are available on our Web site.

At this time, I will turn the call over to Floyd Sherman.

Thank you, Hala, good morning and welcome to our second quarter fiscal year 2007 earnings call. Joining me from our management team are Kevin O'Meara, President, Chief Operating Officer; Charles Horn, Senior Vice President and Chief Financial Officer. I will start with an overview of the second quarter. I will then turn the call over to Charles, who will discuss our second quarter financial results in more detail. After my closing comments regarding our outlook, we will take your questions.

We continued to face very challenging market conditions during the second quarter which pressured our operating results. Housing starts at our markets were down nearly 33% while market prices for lumber products declined 17.7%.

As you may recall, last fall, we outlined our Company's plans to mitigate the pressures being placed on our operating results by these macroeconomic factors and our disciplined strategy continues to help us navigate through these strong headwinds. This strategy includes profitably growing market share. Market share gain had an 8.7% positive effect on our sales during the quarter. Generating incremental sales through new facilities -- new facilities added 2.3% sales growth in the current period. Managing margins -- gross margins were 25.1%, down only slightly from 25.4% on a sequential quarter basis. Maintaining a clear focus on reducing operating cost -- we reduced selling and general and administrative expenses by 15.5%, including a $15.7 million, or 20.3%, decrease in salaries and benefits expense, as compared to Q2 '06.

Finally, we reduced capital expenditures by $6.3 million, or 65.3%. As a result of these initiatives, we were able to generate $31.8 million of operating cash flow, which is 25% greater than last year and achieve a 14.4% return on net assets. Our cash on hand grew to $145 million, lowering our net funded debt to $170 million, or approximately 1.6 times trailing 12 months EBITDA. Our cash flow oriented management approach has given the Company a strong balance sheet which will allow us to grow opportunistically during this downturn, either internally or by acquisitions.

In this environment, we're managing our operations on a daily basis of reacting as quickly as possible to changing customer demand. I'm proud of the ongoing effort company-wide to seek new business opportunities and to operate as efficiently as possible without sacrificing outstanding customer service.

I will now turn the call over to Charles, who will review the financial details further.

Thanks, Floyd, good morning everyone. I will begin by walking you through our sales results for the second quarter. We reported sales of $465.1 million, a decrease of 27.6% compared to $642.4 million for the same 2006 period. Our sales volumes declined 21.9% and sales process feel 5.7% due to lower market prices for lumber and lumber sheet goods. However, as Floyd pointed out, our operating strategy continued to prove beneficial as estimated market share gains and growth from new operations met our expectations for the second quarter. These controllable sales drivers helped to mitigate the substantial decline in housing starts in our markets during the quarter.

If we break down our sales drivers for the quarter, first, we estimate that housing starts within our markets declined 32.9% compared to the same period in 2006. Second, lower market prices for lumber and lumber sheet goods negatively impacted our sales by 5.7%. Conversely, we grew our market share gains an estimated 8.7% and new operations added an estimated 2.3%.

We felt the negative impact of decreased housing starts across all product categories. In addition, our lumber and lumber sheet goods and prefabricated components categories were negatively impacted by commodity price deflation. However, our efforts to transition to higher margin value-added products and services continues to be successful. We believe our product mix geared toward more near toward more value-added products and services give us a distinct competitive advantage to attract new business during this down cycle.

Breaking down our product categories, lumber and lumber sheet goods declined 41.4% to $125.9 million and fell to 27.1% of total sales compared to 33.5% of total sales in the year-ago quarter. The majority of the decrease was attributable to lower unit volumes which had a negative impact of approximately $52.6 million. The remainder was due to lower market prices for commodity lumber products.

Prefabricated components decreased 26.2% from the prior-year quarter due to a combination of lower volume and lower raw material prices, but overall increased to 21.8% of total sales for the quarter. Windows and doors were down 19.6% and represented 22.6% of total sales, up from 20.4% last year. Millwork also declined by 24.4% and represented 9.2% of total sales, up from 8.8% last year.

Lastly, other building products and services decreased 12.3% and represented 19.3% of total sales. The sales decline in this category was mitigated by growth of our turnkey installation services. Even in this difficult environment, install labor revenue was essentially flat with Q2 2006.

Please refer to the table included in our press release for additional second quarter sales data by product category.

Our gross margins, as previously mentioned, decreased and the lumber prices largely contributed to the $53.6 million decline in gross margin dollars. We maintained a strong overall gross margin of 25.1%, down from 26.5% last year. Approximately 80 basis points of the decline between years is attributable to the deleveraging of our lower sales volume against our fixed overhead. On a sequential quarter basis, our gross margins dipped slightly from 25.4% in the first quarter. We were able to partially mitigate substantial pricing pressure from our customers with a favorable shift in sales mix. If market conditions continue to create increased competitive pressure, we may not be able to maintain our gross during the remainder of 2007 at these levels.

Our selling, general and administrative expenses were $99.6 million, down $18.2 million compared to the prior-year quarter. As a percentage of sales, however, SG&A increased from 18.3% in 2006 to 21.4% in 2007. Lower market prices for lumber products increased the 2007 percentage by 160 basis points as many variable costs do not just with changes in price.

Incremental stock compensation expense added $1.1 million for the quarter and increased the 2007 percentage by 20 basis points. Again, we managed our operating cost structure very well during the quarter. On a year-over-year basis, our average full-time equivalent employees decreased 17.9%, while our salaries and benefits expense, excluding the incremental stock compensation expense, fell $15.7 million, or 20.3% from 2006, nearly matching our sales volume decline of 21.9%.

Our interest expense was $6.6 million for the second quarter, down $0.7 million from the 2006 second quarter. The decrease was primarily attributable to increased interest income related to our growing cash balances. These items were partially offset by higher interest rates during the second quarter 2007.

Our effective tax rate decreased from 37.1% to 19.9% for the second quarter 2007 due to state tax law changes and reserve adjustments recognized during the quarter. This added about $0.04 to our APS for the second quarter. We expect our tax rate for the full-year to be approximately 24%.

Net income for the second quarter was $8.4 million, or $0.23 per diluted share compared to $28.4 million, or $0.79 per diluted share in this same period last year. Diluted weighted average shares outstanding for the quarter were $36.4 million compared to $36.1 million in the same quarterly period last year. EBITDA for the 2007 second quarter was $23.1 million, compared to $57.8 million in the prior-year quarter. EBITDA as a percentage of sales decreased to 5% from 9% reported in the 2006 second quarter.

Our balance sheet remains very healthy. Our liquidity is strong with cash of $144.5 million and available borrowing capacity of $107.8 million. We effectively managed our working capital during the quarter by improving inventory turns, lowering accounts receivable days and increasing accounts payable days compared to the first quarter 2007. Our working capital percentage of sales returns below 10% for the quarter. This strong financial footing provides us the opportunity to grow during this downturn through internal means or via acquisition.

Our diligence in effectively managing our working capital amplifies our belief that we have the best working capital management in our industry. As of June 30, 2007, cash on hand grew to $144.5 million and funded debt was $314.7 million. We paid down $0.1 million of debt during the quarter. We are intensely focused on managing our working capital, controlling expenses and conserving capital. As a result, we generated strong operating cash flow of $31.8 million for the second quarter, compared to $24.5 million in the prior-year period. Capital expenditures were $3.4 million dollars compared to $9.7 million in the year-ago quarter. We anticipate 2007 capital spending to be significantly less than 2006 and range from 14 to $16 million, although we will adjust it lower if market conditions dictate.

I will now turn the call back over to Floyd for his closing comments.

Thank you, Charles. The housing environment continues to worsen with national housing starts on a trailing 12-month basis down almost 26% from the peak in March of 2006. We expect continued declines in housing starts into 2008, negatively affecting our operating results.

To help guide you through the market uncertainties, we'll continue to provide updated housing permit and commodity price data on our web site each month. This data is summarized and based on publicly available information.

We continue to seek opportunistic ways to counteract the noncontrollable macroeconomic factors impacting our operating environment, and we'll persistently strive to grow our market share and flex our cost structure while still providing exemplary customer service. We accomplished this in the second quarter, as on a sequential quarter basis, we grew our sales by $54 million, or 13.1%, while increasing our salaries and benefit expense exclusive of stock compensation expense by only $0.1 million, or 0.1%. This leveraging resulted in a 99.3% net flow-through of incremental gross margin dollars in Q2.

Our constant goal is to maintain our market leadership and financial strength in order to deliver long-term shareholder value. I have a great deal of confidence in the abilities of our entire Builders FirstSource team to accomplish this goal. I remain positive about the long-term prospects for the housing industry and I believe our current operating strategy positions us well to take advantage of opportunities when market conditions improve.

I will now turn the call over to the operator for Q&A.

(OPERATOR INSTRUCTIONS). Rob Manowitz, RBS.

This is Michael [Kimon] for Rob Manowitz, good morning. The first question has to do with the senior floating rate notes. In the past, you have strayed away from calling the floating-rate notes, given the two interest rate swap agreements in place. Have you changed your approach at all, given your cash position at quarter end?

Not at this juncture. We always continue to evaluate that on a quarter basis, but at this point, we have not changed our position on that issue.

Great. And in addition, could you give us the current calculation for the restricted payments basket?

Michael, you will probably need to call me after this call. I don't have that data in front of me.

My last question has to do with acquisitions. I guess what's your current appetite for acquisitions? Have you been seeing a lot in your pipeline?

We have been seeing a few opportunities within our pipeline, nothing that is to the point of formally announcing. But, there does appear to be more activity. Obviously, valuation is challenging in this environment, but there is some activity, yes.

Okay, great. Thank you very much, and good luck.

David Manthey, Robert W. Baird.

I was wondering if you could talk about a couple of things from the press release. First of all, you mentioned substantial pricing pressure. I guess that one goes without saying, but the greater mix of installed sales, could you talk about the dynamics that you think is driving that?

I think that's really the continuation of a trend that started several years ago with builders seeking to buy more and more on an installed basis. One of the things that's adding to it in this environment is that as the builders have reduced their own staffs in the field, they rely more and more on companies like ours to provide more of that supervisory service. I think that has probably accelerated the trend to a certain extent.

And then, in terms of your allowance for doubtful accounts, the percentage has increased from 1.1 up to 1.5, but the dollar amount is virtually unchanged. What has your bad debt experience been recently, and any change in the outlook there?

I wouldn't say our bad debt expense as a percentage of sales has really changed. We have seen slight changes in our aging, which is what has been represented there. But overall, the BAR days remain about the same; in fact, they're slightly down from last year. So we haven't seen an appreciable trend, but a little bit of an aging trend that allowed us to increase our reserve.

Okay. And then the final question is related to geographies. We have heard quite a bit about weather impacting the second quarter for some people. Could you talk about -- was there any impact of the weather in Texas? And then maybe if you could discuss just broadly good markets versus bad markets. I don't know if you want to address Florida versus North Carolina or how you want to go about that?

I really don't think that weather has unusually impacted us on an overall basis. In Q2 of this year, there were some spot markets where we did catch some delays where -- due to unusual amounts of rainfall. That was primarily in the Texas markets. But on an overall basis, I could really say that weather was a real significant factor that impacted our results.

In terms of markets, Florida continues to be the worst. If you look at permits within that state, down about 50% year-over-year. In terms of markets still doing pretty well, North Carolina is down about 16%, but then still better than national trend. Tennessee is doing quite well. We did see a couple of markets start to turn down more during the quarter, which are Georgia and South Carolina. And obviously with South Carolina being down 27%, that is our biggest state, so it did have quite a bit of an impact on us.

I think there is significant -- within those markets, Charles, I think we would have to say that we do see some real pockets of significant decrease, especially in the coastal markets that were primarily the second home retirement markets. They're now getting -- have been impacted to a much greater degree than the interior markets.

Thank you very much.

Michael Rehaut, J.P. Morgan.

It's Jenn Consoli on the line for Mike. I just wanted to check in with you guys regarding lumber prices specifically. It looks like over the last month or so, they've really started to firm up. I'm wondering what your outlook for lumber prices is over the remainder of the year, and how, when it does start to improve, that will affect or translate to your results?

Toward the end of Q2, they were starting to strengthen, but I think if you look at recent trends, they're coming back down. So there could be a slight benefit to Q3, but it looks like by the next pricing reset, they will be returning back to the previous levels. So overall, our expectations for the year have not really changed -- that they will be flat. Somewhere in the $255 per thousand composite range.

Once they do start to stabilize and start to improve, what is the lag as to how that will impact your -- or affect your results?

. Because they have been pretty stable. What you will probably see in Q3 is that the overall negative sales impact will mitigate as they basically correlate with the same pricing levels as last year. So I do think you will see that the negative impact of the top line will mitigate in Q3 and Q4. There will really be no margin percentage impact, but you will have overall lower GP dollars just due to the relatively low level of the composite prices.

Okay, great. Thanks.

Walter Branson, Regiment Capital.

A couple of things. Could you comment a bit on the seasonality of your business Q2 to Q3? Last year, your sales dropped sequentially in Q3, but you were kind of heading into the market downturn then. Would you normally expect Q3 to be stronger than Q2?

That would be the normal trend. So although at this point it appears that the decline in starts will continue, therefore it will probably mitigate that typical seasonality.

Okay. In terms of acquisitions, you've made smaller acquisitions in the past. Could you potentially see making a bigger acquisition of $100 million plus?

We try to be opportunistic with the acquisitions, and so it really just depends on what becomes available and what makes sense and how well does it fit, more so than absolute size.

Alright, thank you.

Michael Cox, Piper Jaffray.

Thanks for taking my questions. My first question is on the cash position you have on the balance sheet. I was just wondering if you could just rank order and priority or just the timing of what the use of that cash might be as you look out over the next 12 months?

Michael, I think we'll look first to -- how we can grow the business? As we talked about it, we can grow internally or via acquisition -- can we do that? So that will be the first priority. Again, you cannot cut cost to maintain your profitability during the downturn. You must grow the business. The second, we would look to retire debt. And then, lastly, we would look at either some sort of dividend or share repurchase, but that's a very low probability.

Okay, that's helpful. And, in terms of the cost cutting, you've done an excellent job of managing through this downturn. I'm curious whether -- at which point you start to cut into the muscle of the organization through some of the headcount reductions?

I think that's something that we look at very, very carefully. We have -- I think we have retained our really key people that we need in order to have them in place when -- to take advantage of an improving market and we really don't anticipate that we are going to cut ourselves to the point to where we can't enjoy the improving markets that will be coming in the future.

That's helpful as well. My last question -- given what seems to be a slightly more pessimistic view on the overall backdrop, I was wondering if you have updated your thoughts on facility closures or mothballing certain facilities. And thanks again for taking my questions.

Not at this point. We continue to evaluate them and we'll evaluate our markets through this downturn. But really at this point, we don't have any that we're particularly concerned about. We do monitor them from a goodwill impairment standpoint. Again, we're not at a point where we're worried about that. But, as conditions continue to develop, we will continue to look at markets that we deem underperforming, and at that point, we may decide to either close some facilities or exit a market. But we're not at that point.

Keith Hughes, SunTrust.

On working capital will we see in the second half a continued draw-out of working capital, or is it at the point now where it would remain flat as the year progresses?

I think there's still a benefit that can be had, Keith. We dropped to about 9.8% of sales. If you look at last year, we were below 8%. It takes awhile to get ahead of the downward trend in terms of your inventory management, but we're doing that and we're increasing our inventory turns. As I said earlier, our DSO is pulled back into line, and we continue to go out and we negotiate with our suppliers to extend our payable days. The favorable change in sales mix is also benefiting us from a payable days. So I do think there is some opportunity to improve that in the Q3 and Q4.

We had several questions here on acquisitions. I was just wondering, given that it doesn't seem to be -- we don't seem to be at the bottom of this cycle of home building. Is there still a hesitancy to do particularly large transactions just not knowing where the numbers could go in the short-term? Is that part of your thinking?

Of course, it has to be.

Would that be true across the industry, in your opinion?

Yes.

Okay. And I guess final question. Charles, on the tax rate, the 24% for this calendar year you discussed earlier, would that continue into 2008?

No, I think you will just see it jump back up into a mid 30s range back in 2008. Basically, we took advantage of a change in [Texas] margin tax laws, then we took advantage of a FIN 48 accrual reversal. So I think you will see it return to normal back in '08.

Alright, thank you.

[Nitin Dehaya], Lehman Brothers.

Since everyone is asking acquisition questions, I thought I should as well. Clearly from a -- you've said that you wanted to be opportunistic, and to the previous question, you said that obviously there is some hesitancy in terms of timing it. But then, is your inclination right now to kind of do tuck-ins, or to do a transforming, if you like, you know, a big acquisition which would, say, increase your size by 50%, 100%? Do you have a preference of one type or the other?

It just depends on what becomes available and after we do our analysis and look at markets, what makes sense. You may see us do things that are fairly small. It just kind of depends on what comes about and what makes sense both for the target as well as for us financially on a pro forma basis after the acquisition.

Of course. So you don't necessarily have a preference of one of the other? Whatever makes sense, you're okay with either?

Yes.

Fair enough. And then on working capital, you said the back half is going to be a source. And I was just looking at your payables. You've been extending them -- this quarter, payable days was 34 versus 24 in the fourth quarter. Now is there some timing in this, or is it like a permanent extension? We should continue to see this benefit, or do you expect payables to come down, I don't know, closer to a 30 level?

There's obviously a timing aspect if sales are trending down at the end of Q4 due to seasonality versus trending up at the end of Q2 due to seasonality. That's going to have some impact. The shift in mix, if you see the continued shift away from lumber and lumber sheet goods, they tend to carry the lowest payable days. And so that shift is naturally going to move it as well. I think on average for the quarter, you will see us coming in around 30 to 32 days, and then at a point in time, probably somewhere around 30 to 33 days. So I don't think it's going to change substantially, but it will remain pretty much where it is.

The other thing that can drive a change, Charles, is if we keep accelerating our percentage of installed business, because the installed biz is because of the installed labor component, it adds much lower payable days in it. But we don't anticipate that that is going to continue at the same rate.

So probably a 10, $15 million kind of a source in the back half could be fairly realistic?

I think that's realistic, yes.

Fair enough. Thank you very much.

Steven Fisher, UBS.

Good morning. You've continued to have some nice share gains. I wonder if you can just talk about some of the competitive dynamics in your markets. Where do you think you're getting the share gains from today, and would any of those share gains maybe be contributing to some of the margin pressure?

I think that the share gains are fairly broad-based, again, kind of our basic strategy of leveraging the components as well as the installed sales. I think that's really driving the share gain as much as anything else. Steven, obviously, it's always a trade-off between margins and market share gains, and that is true in any environment. In this environment, it's particularly true, and that's something that our people think about everyday in every location is how do they trade that off and what makes the most sense for the operation on an overall basis. And so, that is a balancing act that we work very, very hard at achieving.

And in terms of margins, how are the margins on prefab components faring relative to some of the other categories? I'm wondering if your customers perceive that as the higher value-added product that it is that might give you some relative pricing abilities there?

You would get us back to what we had indicated earlier. We're seeing pricing pressure pretty much against all categories. Is it still holding it pretty well? Yes, but every category is coming under pressure. Again, it's our focus on changing the mix that will help us mitigate it. If you look at much of the decline year-over-year, the 26.5 to the 25.1, about 80 basis points of that is just the lower sales volume against our fixed cost embedded in our manufacturing operations. So we're managing it pretty well, but there's still going to be pressure coming in that category as well.

Okay, great. Thanks.

(OPERATOR INSTRUCTIONS) Jay McCanless, FTN Midwest.

First on lumber inventories for the industry, are those still pretty high relative to where we would expect them to be, and what is your outlook for that?

It would appear from the industry stats that, yes, the lumber inventory is still higher than what one would normally expect or anticipate in this business. It looks like there's going to continue to be a downward pressure on pricing on lumber and lumber sheet goods as we go into the next quarter. We're always hopeful that we'll see this situation reverse. But I think, just like in housing, with a full inventory, it definitely is going to affect and have more downward effect on pricing.

Okay. What has been the trend? I mean, [do] we see numerous OSB mill shutdowns? Have we seen -- do you expect that trend to continue or increase? Or what is your outlook for capacity coming out?

I can't tell you what the OSB producers are going to do. I would anticipate that they will be looking very closely at trying to balance the output with the demand that's out there. They have always been very successful at doing this in the past. I think some of the problems that you're running into is that as these new mills have come onstream, they're so much more efficient than some of the older mills. And while they may start curtailing the production levels in some of the older mills, the new mills are turning out and improving to be a lot more productive than what they had anticipated. And I think that's giving them some balancing trouble. But I -- ultimately, I think that they will get supply and demand in balance, and I think that we should see a -- long-term, I think that we'll see a healthier market.

And then in listening to the conference calls of your customers, the production builders over the last several days, the trend or the overwhelming theme that we've heard from a lot of them is that conditions in Georgia and South Carolina slowed down appreciably during the second quarter. I know you spoke to it a little bit earlier, but I was going to see if you could dig in a little bit deeper and maybe give us some insight as to why that happened.

I think it's probably just timing, as much as anything. In our markets, if you remember, we first started talking about Washington D.C. getting soft quite some time ago, and I think it's just kind of a wave rippling through. Those Carolinas markets, the southeastern markets, held together longer than, say, Florida and Washington D.C. And I think what you're seeing is that they're kind of catching up with just the overall national downturn. It just, for whatever reason, it happened later, and so it's happening now rather than six or nine months ago.

My final question, I have an acquisition question as well. Is your current thought right now to maintain the footprint that you have, or do you believe that it may be time, given the weakness that we have seen now for two years in this industry, that it may be time to start broadening out your footprint and look for outside acquisitions?

Well, you look at it from two aspects. One is -- what are your customers demanding of you, and then what do you need to do on the supplier front? Really, nothing has happened that is compelling that says that we have to dramatically broaden our footprint either on the customer side or on the supplier side. We have achieved sufficient scale to where our supplier relationships are excellent and we're very competitive there. And, again, on the customer side, nobody is demanding and saying you absolutely must expand your geographic footprint. From time to time, a customer would say, gosh, it would be great if you could open up a facility in X-location. Actually, that is how our San Antonio truss and panel plant came about. We had a customer that said, we love what you do for us in another market. Can you replicate that in San Antonio? And so, we did market research and ended up opening up that plant. That has really been what it has been limited to, to this point in time. But, again, we'll look at it opportunistically, and if something makes sense and is of scale that is outside of our footprint, than we certainly would take a hard look at it.

My final question also about your customers. I believe 26% was the number that you used to use about -- 26% was the amount of your customers who were the larger production builders. What is your outlook for that? Where do you think that number could go, especially as we see some of the smaller builders in your region either go into bankruptcy or just give up the business for awhile and start doing repair and remodel work?

I think in the short-term, you're going to see that number down, and for the six months of this year, it has gone down to about 23%, and I think that's just to say to react quicker than some of the smaller builders within the market. And then I think if that starts to moderate and things turn, it will come back up and grow at a greater rate than what we would with the smaller builders. But I think in the short-term, you'll see that percentage drop.

Okay, great. Thank you.

At this time, there are no other questions in the queue. Mr. Sherman, I would like to turn the call back to you for any closing comments.

Thank you for joining us today. If you have any further questions, please feel free to contact Charles Horn.

Thank you. This does conclude the Builders FirstSource conference call. You may now disconnect. Thank you.