Business Context and Reporting Period
Builders FirstSource, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2017. The company supplies and manufactures building materials, components, and construction services for professional homebuilders, subcontractors, remodelers, and consumers through approximately 402 locations in 40 states. Reportable segments are Northeast, Southeast, South, and West.
Financial Performance and Position
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Sales | $1.879 billion | $1.746 billion | $5.255 billion | $4.820 billion |
| Gross margin | $459.3 million; 24.4% | $437.1 million; 25.0% | $1.296 billion; 24.7% | $1.205 billion; 25.0% |
| Income from operations | $88.7 million; 4.7% | $86.3 million; 4.9% | $220.3 million; 4.2% | $185.5 million; 3.8% |
| Net income | $39.8 million | $125.5 million | $81.5 million | $137.9 million |
| Diluted EPS | $0.34 | $1.10 | $0.71 | $1.22 |
| Net interest expense | $33.8 million | $92.3 million | $103.7 million | $170.3 million |
At September 30, 2017, cash was $9.3 million, total assets were $3.093 billion, total liabilities were $2.681 billion, and stockholders’ equity was $412.0 million. Total debt and lease obligations, net of discounts and issuance costs, were $1.851 billion, including $55.0 million drawn on the revolving facility, $464.1 million under the 2024 term loan, $367.6 million of 2023 notes, $750.0 million of 2024 notes, and lease obligations.
Net cash used in operating activities for the first nine months was $7.6 million, compared with $3.7 million used in the prior-year period. Investing cash outflow was $43.3 million, including $48.1 million of capital expenditures. Financing activities provided $45.7 million, primarily reflecting net revolving-facility borrowings.
The company reported $760.1 million of net excess borrowing availability under its $900.0 million revolving facility and total liquidity of $769.4 million, including cash. The company was in compliance with its debt covenants at September 30, 2017.
Material Changes Versus the Prior Comparable Period
- Q3 sales increased 7.6%; nine-month sales increased 9.0%. Management estimated Q3 volume growth of 0.7% and commodity-price-related growth of 6.9%; nine-month volume growth was 3.2% and commodity-price-related growth was 5.8%.
- Gross margin percentage declined 0.6 percentage points in Q3 and 0.3 percentage points for the nine months, primarily because commodity-cost inflation outpaced the company’s ability to adjust short-term customer pricing.
- SG&A increased in dollars but improved as a percentage of sales, to 19.7% from 20.1% in Q3 and to 20.5% from 21.2% for the nine months, reflecting operating leverage partly offset by growth investments.
- Operating income increased 2.8% in Q3 and 18.8% for the nine months, despite lower gross margin rates.
- Net income and EPS declined sharply because the 2016 periods included significant non-cash deferred-tax valuation-allowance releases. Q3 2016 also included substantial debt-financing charges that increased interest expense.
- Net interest expense declined by $58.5 million in Q3 and $66.6 million for the nine months, primarily because of prior debt transactions and the absence of comparable 2016 debt-extinguishment and financing charges.
- Working-capital investment increased, with accounts receivable and inventories rising from December 31, 2016, contributing to negative operating cash flow.
- The company amended and extended its term loan and revolving facility in the first quarter of 2017, reducing the term-loan interest margin, extending maturities, and increasing revolving commitments from $800.0 million to $900.0 million.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
The filing does not provide formal company-specific financial guidance. Management expects long-term housing demand to improve and intends to pursue market-share gains, operating efficiency, working-capital discipline, potential strategic acquisitions, and debt reduction. External forecasts cited in the filing projected 2017 U.S. total housing starts of 1,208,500, single-family starts of 840,500, and professional repair-and-remodel sales growth of approximately 3.4%.
- Housing starts remained below historical averages, and the business is exposed to housing cycles, interest rates, credit availability, consumer confidence, labor shortages, local economic conditions, competition, and weather.
- Lumber and other material prices can fluctuate significantly. Short-term customer pricing commitments may prevent the company from passing through cost increases, creating margin pressure.
- Third-quarter sales were affected by one fewer selling day and Hurricanes Harvey and Irma. Repair-and-remodel sales were flat and multifamily sales declined.
- The company faces increased construction-defect claims, primarily in two states. Insurance may cover losses above deductibles, but the company cannot currently estimate a reasonable loss range and states that resolution could materially affect financial position, results, or cash flows.
- A shareholder ownership change triggered Section 382 limitations on tax attributes. Management does not expect a material effect on future utilization, but the impact on certain attributes remained under evaluation.
- The company adopted updated stock-compensation accounting guidance, recording an $8.9 million cumulative-effect increase to accumulated deficit. It also adopted revised inventory guidance without a material impact.
- The company expects a significant balance-sheet impact from the future lease standard because of its substantial operating-lease portfolio. It planned to adopt the new revenue-recognition standard on January 1, 2018, primarily affecting service-element contracts and potentially accelerating recognition of deferred revenue.
- A 1.0% increase in interest rates would increase annual interest expense by approximately $0.6 million on the revolving facility and $4.6 million on the 2024 term loan, based on outstanding balances at September 30, 2017.
Investor Verification Items
- Verify whether commodity-price inflation continues to pressure gross margins and whether customer pricing can be adjusted quickly enough.
- Reconcile reported earnings with the significant tax valuation-allowance releases in 2016 and assess the sustainability of the 2017 effective tax rate.
- Review debt maturities, variable-rate exposure, covenant requirements, and the availability and borrowing-base mechanics of the revolving facility.
- Monitor seasonal working-capital needs, negative operating cash flow, capital expenditures, and future debt-reduction capacity.
- Track construction-defect litigation, insurance coverage, deductibles, and any subsequently estimable loss range.
- Assess housing-start trends, skilled-labor availability, lumber prices, repair-and-remodel demand, and multifamily activity by region.
- Confirm the implementation effects of the new revenue and lease accounting standards, including impacts on timing of revenue, assets, liabilities, and equity.