Business Context and Reporting Period
Builders FirstSource, Inc. filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. The company supplies building materials, manufactured components and construction services through approximately 400 locations in 40 states. Results are substantially affected by the July 31, 2015 acquisition of ProBuild; therefore, year-over-year comparisons are not fully comparable.
Financial Performance and Position
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Sales | $1,746.0 million, up 36.8% | $4,820.4 million, up 128.6% |
| Gross margin | $437.1 million; 25.0% | $1,205.2 million; 25.0% |
| Income from operations | $86.3 million; 4.9% of sales | $185.5 million; 3.8% of sales |
| Interest expense, net | $92.3 million | $170.3 million |
| Net income | $125.5 million; diluted EPS $1.10 | $137.9 million; diluted EPS $1.22 |
Net income benefited from non-cash deferred tax valuation allowance releases of $117.6 million in the quarter and $128.6 million year to date. Excluding the valuation allowance effect, management reported effective tax rates of 53.2% for the quarter and 38.2% for the nine-month period.
Gross margin declined from 25.5% to 25.0% in the quarter, primarily because commodity price inflation exceeded the company’s ability to adjust short-term customer pricing. Nine-month gross margin improved from 24.6% to 25.0%, supported by the ProBuild acquisition and improved profitability in value-added products.
Cash used in operating activities was $38.1 million for the nine months, compared with $118.8 million of cash provided in the prior-year period. Working capital increased $163.1 million, principally because of higher receivables and inventories. Capital expenditures were $34.1 million, and cash used in investing activities was $35.3 million.
Cash and cash equivalents were $5.9 million at September 30, 2016, compared with $65.1 million at December 31, 2015. Total liabilities were $2.752 billion and stockholders’ equity was $300.3 million. Total debt and lease obligations before unamortized discounts and issuance costs were approximately $1.975 billion.
Material Changes Versus the Prior Comparable Period
- Quarterly sales increased 37%, with approximately 35 percentage points attributable to ProBuild and approximately 2% estimated organic growth.
- Nine-month sales increased 129%, primarily from acquisitions; excluding acquisitions, management estimated growth of approximately 5% from increased volume.
- Quarterly SG&A declined to 20.1% of sales from 22.5%, and nine-month SG&A declined to 21.2% from 22.0%, reflecting synergy savings from payroll, delivery-cost reductions and location consolidations.
- Interest expense rose substantially because of acquisition-related debt, refinancing costs, redemption premiums and lease obligations assumed with ProBuild.
- Net income improved from a $8.8 million quarterly loss and a $12.3 million nine-month loss in 2015, but the 2016 results include the significant deferred tax benefit described above.
Debt, Liquidity and Refinancing
- In August 2016, the company issued $750.0 million of 5.625% senior secured notes due 2024.
- Proceeds, cash and revolving borrowings were used to redeem $582.6 million of 2021 notes, repay $125.9 million of the term loan and pay transaction costs.
- The term loan was repriced, reducing applicable margins by 1.25 percentage points; $468.8 million remained outstanding at September 30, 2016.
- Revolving borrowings were $89.0 million under an $800.0 million facility. Net excess borrowing availability was $626.0 million after letters of credit.
- Reported liquidity was $631.9 million, consisting of cash and net revolving availability. The company was in compliance with its debt covenants at quarter-end.
- Management expects the 2016 debt transactions to reduce annual cash interest expense by approximately $34 million going forward.
- In October 2016, the company repurchased $50.0 million principal amount of 2023 notes at 117% of par plus accrued interest, funded with cash and revolving borrowings.
Outlook, Commentary, Risks and Unusual Items
Management characterized the long-term housing outlook as positive and cited improving housing starts, demographics, low interest rates, aging housing stock and expected repair-and-remodel growth. The company cited forecasts of 786,000 U.S. single-family housing starts in 2016, up 9.9% from 2015, and approximately 6.0% repair-and-remodel sales growth.
Management intends to pursue market-share gains, operating efficiencies, working-capital discipline and potentially strategic acquisitions while continuing to integrate ProBuild. The filing does not provide formal earnings or revenue guidance.
- Housing starts, mortgage and commercial credit availability, interest rates, employment, consumer confidence and broader economic conditions could materially affect demand.
- Lumber and other commodity price volatility may compress margins when customer pricing commitments prevent timely pass-through.
- The company has substantially increased leverage following the ProBuild acquisition, creating higher interest expense and reduced financial flexibility.
- Integration of ProBuild may be more costly, difficult or time-consuming than expected, and anticipated synergies may not be achieved.
- Seasonality, weather, skilled-labor shortages, competition and customer concentration may cause quarterly volatility.
- Legal proceedings and environmental matters are considered ordinary course and not expected by management to have a material adverse effect, although future costs cannot be assured to be immaterial.
- Major unusual items included the deferred tax valuation allowance release, a $43.9 million loss on redemption of 2021 notes, $8.2 million of term-loan refinancing write-offs and other debt extinguishment gains and losses.
Investor Verification Points
- Separate sustainable operating performance from the $122.8 million year-to-date income tax benefit and other non-recurring refinancing items.
- Verify organic sales growth and margin trends excluding ProBuild and commodity-price effects.
- Monitor operating cash flow, receivables, inventory and seasonal working-capital requirements.
- Review debt maturities, variable-rate exposure, covenant requirements and the effect of the October 2023-note repurchase.
- Assess whether ProBuild integration savings and the projected approximately $34 million annual interest reduction are being realized.
- Evaluate exposure to housing starts, lumber prices, credit availability and labor constraints.