Paul M. Isabella - Beacon Roofing Supply, Inc. Joseph M. Nowicki - Beacon Roofing Supply, Inc..

Ryan J. Merkel - William Blair & Co. LLC Keith Hughes - SunTrust Robinson Humphrey, Inc. Brian Biros - Thompson Research Group David J. Manthey - Robert W. Baird & Co., Inc. Matt McCall - Seaport Global Securities LLC Garik S. Shmois - Longbow Research LLC Trey Morrish - Evercore Group LLC Jay McCanless - Wedbush Securities, Inc. Trey H.

Grooms - Stephens, Inc..

Good afternoon, ladies and gentlemen, and welcome to the Beacon Roofing Supply's Third Quarter 2018 Earnings Conference Call. My name is Tawanda, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of the conference.

At that time, I will give you instructions on how to ask a question. As a reminder, this conference call is being recorded for replay purposes. This call will contain forward-looking statements including statements about its plans and objectives and future economic performance.

Forward-looking statements are only predictions and are subject to a number of risks and uncertainties.

Therefore 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 set forth in the Risk Factors sections of the company's latest Form 10-K.

These forward-looking statements 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.

The forward-looking statements contained in this call are based on information as of today, August 7, 2018, 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. The company has posted a summary financial slide presentation on the Investors' 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 in 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..

improve price-cost, gross margins, expense control and continue our progress on the integration of Allied. And I'm pleased to say we exceeded internal expectation on all of these. First, price-cost was positive.

This was a concern from many of you after Q2 when we said it was timing, seasonally-related, and that we would improve as we progressed through the year. Well, we did even better than the expectations I gave you on the second quarter call. This shows our ability to execute operationally, and I'm very proud of our team on this point.

In addition, gross margin was up year-over-year and sequentially. We achieved solid expense control and leverage, and we made continued progress integrating Allied.

Our year-to-date organic growth is close to 4%, and adjusted EBITDA is up approximately 32%, while gross margins were up versus last year, even factoring in the negative price-cost we saw in Q1 and Q2.

The third quarter did present volume challenges in residential roofing, but that almost entirely is attributable to soft storm volume and comps in the West which although disappointing, is not concerning to us long term, nor does it detract from the extremely positive results we saw in key metrics this quarter.

The industry data we see for these markets supports the challenges seen in the quarter, and four of the seven reported regions had double-digit or close to double-digit growth in the quarter. In terms of Allied, we remain on track to hit the increased synergy expectations that we provided last quarter; $120 million in total and $40 million in 2018.

And of course, we're working to exceed these. The integration of the Allied team has gone extremely well, and we have many key Allied people in leadership positions. Allied is an outstanding acquisition and had added to legacy Beacon in many areas of our business including pricing, the distribution model and private label, to name a few.

As we look to the fourth quarter and beyond, we're extremely optimistic about our strategic direction and focus. Of course, we will always have the possible impact of short-term regional weather challenges to deal with, but that is not a new phenomenon.

As many of our long-term holders could speak to, we have demonstrated a commitment and resilience to grow over time, through any cycle and above-market rate. In fact, our focus on the many elements of growth fuel this belief for our future as well.

This includes national accounts, increased focus on complementary products, including our interior business, siding, waterproofing and insulation, two-step sales and new construction; of course, the overall 70% piece of our business that's focused on roofing and specifically on the repair and remodel segments.

Another important growth lever and sales enabler to highlight is our digital platform. Beacon Pro+ and Beacon 3D (sic) [Beacon 3D+] are the industry's leading e-commerce and estimating tools respectively, that leverage our offering are based on a full digital product catalog we have developed.

These digital tools were developed with our contractor customers in mind with the intent to help them save time, work more efficiently and help them enhance their businesses. We formally launched Pro+ in March of 2017. We learned a lot in the first six months with a strong sales ramp that began to gain even greater velocity this fiscal year.

The sequential ramp in sales and new customers has been tremendous, and we're seeing diverse usage across our different regions and product categories.

Customer feedback from users has been very positive, and we're continuing to train our employees on the offering while simultaneously adding new user functionality to what is already the strongest platform in our industry. We believe the long-term potential is huge.

We have taken a leadership role with respect to digital, and we're committed to investment levels that will deliver a world-class experience. This technology is additive to our pricing disciplines and improves our branch efficiency, while providing innovative services to our customer base.

In fact, we receive consistent customer feedback that Pro+ saves our contractors' time and helps them be more efficient as well. In return, we believe we're creating more loyal customers to Beacon and our growing digital platforms.

Private label is another unique value proposition for Beacon in that we believe it provides us with both revenue and gross margin benefits for the company. We have an established brand called TRI-BUILT that is approaching 10 years of brand equity and product performance in the marketplace.

Customers like having a unique private label option, and TRI-BUILT positions us to drive higher margins versus what is more typical of a branded product sale. This has huge potential, and we're committed to resourcing it in a way that will deliver significant impact for the company.

Lastly, from a strategic standpoint is growth via acquisition in greenfield locations. Our acquisition pipeline remains full and we'll continue to evaluate and potentially execute tuck-in acquisitions moving forward. The recent Atlas acquisition is an example of this. Related to greenfields, we plan on opening 10 to 15 per year over the next few years.

Greenfields have been an effective organic growth vehicle for us and we believe there's enough geography in the U.S. and Canada to continue expanding for the foreseeable future. As we execute our strategic plan, we will generate substantial free cash flow over the next five years.

We will put this to good use for the future growth while also paying down debt to the levels we had previously talked about. Our future is bright. The overall industry is still very strong. More importantly, we have a tremendous team that remains focused on customer service and the overall execution of our strategic plan.

With that, I'd like to turn the call over to Joe to provide additional details..

Thanks, Paul. Good afternoon, everyone. I'll now provide additional details related to our third quarter financial results and also an update on our 2018 guidance. Overall, we had a very good quarter.

We had strong year-to-year gross margin gains of 100 basis points and sequential gross margin gains of 180 basis points, highlighted by achieving positive price-cost ahead of our anticipated timeline. We also demonstrated strong operating cost controls, which saw us do a great job of adjusting expenses in response to softer market demand.

Our adjusted EPS was $1.18, solid gains compared with a year ago at $0.97. And adjusted EBITDA was $188 million versus $120 million last year, that's a 57% increase. It's worth noting that our quarterly EBITDA is actually greater than any of the other full years, other than fiscal 2016 and 2017.

This really provides an indication of just how far we've come the past several years. One of our top strategic priorities is around driving total growth. We had outstanding performance this quarter as our overall sales growth was 59.4%, led by the strength of our acquisitions combined with 2% existing market growth.

Our existing market sales growth reflects diverging geographic performance with strength across our Northeast Corridor into Canada and also in Florida, but offset by difficult hail comps in many other markets. Our overall pricing was up approximately 5 points during the third quarter.

As with Q2, pricing increased in all three of our product categories. In fact, our price improvement has now continued to expand sequentially in every month of 2018.

Based on the revenue change in the traditional hail market states, we estimate that the year-to-year drop in hail-related business created a sizable high-single-digit drag on our overall organic unit sales.

Similarly, based on the revenue change in Florida as a result of Hurricane Irma, we estimate a year-to-year benefit to overall organic unit sales of low-single digits.

So in total, when you exclude the impact of the traditional hail markets and the benefit of the Hurricane Irma in Florida, we believe our organic unit growth was low-single digits for the quarter. In fact, four of our seven reported regions even grew organic sales in excess of 10% for the quarter.

Severe storm demand remains a relatively small part of our overall business and most significantly impacts the residential roofing category. While the volatility created by this year's lack of activity is disappointing, we believe it reflects an extreme swing from two consecutive above-normal storm years to a very inactive season in 2018.

Our July results followed the pattern of May and June and were down in mid-single digits, but all of the decline was again driven by the same post-storm markets as discussed above. Now I'll move on to one of our other key strategic priorities around driving improved gross margins. Here again we also performed exceptionally well.

Our company-wide gross margins increased 100 basis points year-to-year, reflecting the strength of our acquisitions and also within our existing markets. The existing market gross margins realized a very strong 35 basis point improvement.

This performance is even more impressive when you recognize that we faced meaningful product mix-related headwinds. In addition, price-cost was positive during the quarter. Our product cost increased approximately 4.5%, which compares favorably to approximate 5% increase in our prices.

During our second quarter call, we had guided to a slower pace in price-cost recovery. Excellent work from the entire organization in communicating the inflationary pressures to the market created this favorable result. History shows us that roofing distribution achieves positive pricing during inflationary periods, and Q3 demonstrates this.

We have always felt that nothing has structurally changed in the industry, and we would benefit from inflationary environments as we saw this quarter. While we understand that price-cost is top of mind for investors, it's not our only gross margin based initiative. Allied related procurement synergies were very attractive during Q3.

It's also noteworthy that Allied's pricing team and the expanded use of technology in assisting our overall pricing disciplines as a company. As part of these capabilities, we can shift share between manufacturers on a market-by-market basis. We're also maintaining our focus on adding higher-margin products to our branches.

The TRI-BUILT private label offering and our continued emphasis on attractive margin complementary product categories are indicative of these efforts. Shifting gears now to operating costs, another of our key strategic priorities around driving operating expense leverage.

Adjusted operating costs were $329 million, about $10 million better than our plan. Allied related synergies came in better than expected. We're also very pleased with our existing market expense controls during the period.

Despite modest top-line quarterly growth, existing market SG&A as a percentage of sales was approximately the same as the year-ago period, again excellent core cost control efforts throughout the organization. Given the softer volumes than anticipated, we implemented targeted cost reduction activities during Q3 that's beyond our Allied synergies.

This should also help us as we go forward into Q4. Continuous improvement has always been one of our core strengths, and you'll see that show through in the upcoming quarters. Lastly, I want to move to our updated guidance expectations for fiscal 2018. We are reducing 2018 revenue expectations to a range of $6.45 billion to $6.55 billion.

And for adjusted EBITDA, our new range is $510 million to $520 million with an adjusted EPS range of $3 to $3.10. For Q4, this implies revenue of $1.975 billion to $2.075 billion, adjusted EBITDA of $205 million to $215 million and adjusted EPS from $1.35 to $1.45.

These changes reflect the detrimental impact from softer storm demand within traditional hail markets, our Western regions. We anticipate some improvement in sales during August and September given continued price escalations and also benefits from the lagged impact of the June/July month, the new hailstorm events.

We expect our gross margin performance will be relatively stable sequentially, reflecting continued confidence on our ability to sustain a positive price-cost relationship into Q4 and beyond. We continue to anticipate tight controls on our operating costs during the fourth quarter, and overall synergy contributions will be similar to Q3.

Our adjusted EBITDA margins should improve nicely on a sequential basis and should be flat to modestly up on a year-to-year basis, a strong accomplishment given the unfavorable storm demand environment. Overall EBITDA dollars, though, should be up an impressive 55% to 60% in Q4.

One final comment to head off any potential confusion, there have been no changes to the 2018 guidance for our share count related to adjusted EPS. For additional detail, please see the footnote following the adjusted net income statement that's in our press release. I will now turn it back to Paul before taking your questions..

Thanks, Joe. I want to reemphasize a couple of points. We believe the long-term outlook for our industry remains highly attractive with favorable, cyclical characteristics and a strong foundation based on repair and remodel. We've said this before.

The industry is again transitioning to an inflationary environment and consistent with previous cycles, higher pricing is steadily and successfully moving through the channel to offset higher raw material and transportation cost.

As a company, we play a vital role connecting this supply chain and have never been in a stronger position to lead on price recovery and to lead with growth initiatives benefiting our customers. As a result, we are confident we will deliver above industry growth rates and attractive margin expansion long term.

With that, I'd like to turn the call back over to the operator to initiate the Q&A portion of the call..

Thank you. Our first question comes from the line of Ryan Merkel with William Blair. Your line is open..

Hey. Good morning – or good afternoon, I should say, everyone..

Hey, Ryan..

Hey, Ryan..

So a few puts and takes in the quarter.

But first, can you discuss if your competitors are also pushing price in the marketplace as you are? Or are there still bad actors out there going after volumes at the expense of margins?.

Yeah. I think, Ryan, without getting too long-winded, as you know, in any market, right, where it's strong or soft, there's going to be different behaviors. We've said this for years. We believe we've – had led on price and we believe our competitors have followed, as best we can tell.

Now within that, there's always deviations but that's what we believe. So for us, it's positive, and that's kind of was my summary comment..

Yeah. I think that's a good thing that you're pushing price and certainly, the industry needs it. And then secondly, I just want to understand the main reasons for the lower guidance. I think I heard that it's below average hail season that's driving lower industry volumes.

But is there anything else?.

No. Because if you – no, it's really all predicated on what's happening in the West. Most of it, hail that really – the repair work got done quicker in our view than we had anticipated as we put our estimates together for the back half. And then the fact that there was – has not been any meaningful new hail.

There's a little bit, Texas and Colorado, but not much. California has been very dry, so all the goodness they have seen has really run out in terms of some of the great growth we've seen there. So they're going through a lull period.

But if you do look at our East Coast regions, and I mentioned the four of the seven for the quarter, they're still strong. They're – some – one of them was up 15%-plus. That's really the prime reason.

So everything else as Joe talked about, sequential gross margin, price-cost still being positive, control of expenses and leverage, the additional actions we've taken on the cost side, it's all there. This is all volume driven..

Got it. All right. Thanks. I'll pass it on..

All right..

Thanks, Ryan..

Our next question comes from Keith Hughes with SunTrust. Your line is open..

Thank you. You talked about 5 points of price in the quarter.

Was it 5 points in residential roofing or was that a little different?.

This is Joe. Hey, Keith. So in regards to the price improvement, they were all pretty close to that 5% range where we came in on average. So they all were around that same approximate range. A little bit more or less in some, but they all came in pretty consistent to that..

Okay. That was -.

And it was 5% average for the quarter..

Okay. And so that would put units down high single digits in residential.

Is that about correct?.

Yeah. That would be approximately correct. Yes..

So the – if we look at the comps in residential, they get harder for the next two quarters.

So given kind of your hail comment and absent any kind of windstorm damage in the next two months, the year-over-year numbers in this guidance, would it be lower than that?.

No. I mean the guidance is all predicated on what we saw exiting the quarter, even what we saw in July. We understand the comps year-over-year. There is a little bit of hail, as I mentioned, in Colorado and Texas that'll help us, not to any huge degree as these past storms we saw the past two years. So we feel comfortable with the guidance.

And it implies flattish for the quarter, right, so we're not anticipating any organic – this is organic growth in the quarter..

Right.

And do you think residential will be flattish in the fiscal fourth quarter, is that correct?.

Overall growth. So, our overall growth in regards to August and September, we believe, will be flat organic. As I said, July was down mid-single; August, September will be probably flat on organic sales part..

And then turning to Allied, we don't really have prior-year numbers.

What was their organic number like for the quarter?.

Hey, this is Joe. Unfortunately, it's difficult for us to track the Allied business separately, because as you know, we've combined and consolidated a lot of the branches together. So as we do that, the combined branches, we move into what we call our acquired markets.

So, it's very difficult to say exactly what the Allied branches kind of did because it's not the same unit as it was before. That's why we'll be talking in total how the business did..

Yeah. All right. Thank you..

Thanks, Keith. You bet..

Our next question comes from the line of Kathryn Thompson with Thompson Research Group. Your line is open..

Hi. This is Brian Biros on for Kathryn Thompson. Thank you for taking my questions today. I wanted to get more color on the gross margin and SGA front. And if you could kind of bucket that out across core Beacon and then how it might apply to Allied and the distribution consolidation and any other buckets that might have contributed to that..

Yeah. This is Joe. I'll take a stab at walking through the piece on both the questions in regards to gross margin and SG&A. So on the gross margin, say, probably the best thing I'd say about gross margin is referring to what I went to in my prepared comments.

What you really saw was a combination of strong price-cost, right, so the 5% price increase that we received, roughly around a 4.5% cost offsetting it. So, positive price-cost in there. We did lose a little bit because of the mix, so we had a higher mix of commercial products. So you saw our gross margins down slightly because of the mix element to it.

And then again, we saw a good improvement as a result of the acquired businesses as well, as you see that, too. It's probably the big elements that are driving our change in the gross margin piece. On the OpEx side of it, you saw improvement both in the existing markets side as well as the Allied part as well, too.

On the Allied side, a big driver there is the integration. As Paul said, we're making great inroads in our integration. Our synergies are kind of on track, slightly ahead as we had described. So we're doing great on the synergy side. So, you're seeing a nice improvement on our acquired markets operating expenses.

And on the existing markets side, we did a great job this quarter with the teams that's really driving some additional improvement. Beyond the work from the Allied synergies, we had some targeted cost out activities that we took in place as well, too, focused on where the volumes were lower and to really adjust our operating expenses as well, too.

So, the teams did a great job. So you saw great improvement on both sides on operating expense as well..

Thank you..

Thank you. Our next question comes from the line of David Manthey of Baird. Your line is open..

Thank you. Good afternoon, guys..

Hi, Dave..

First off, Joe, you mentioned that price was about 5% for each segment. I'm wondering if you can give us a little more quantitative answer there in terms of what the price versus volume was by segment.

And then if you could talk about what the trend looked like through the quarter, and also if you could do the same thing for price-cost just to give us an idea of how fast you caught up and where you are..

Sure. I'll give you a little bit direction there. I probably may not go into as many details, Dave, just trying to be cautious of not providing too much competitive information. In general, what you saw was, sequentially, price increased every month.

So as we went through every month of the quarter, I think we talked about the number at the beginning of the quarter in April. You saw improvement in both May and June results as well, too. So that sequential improvement continued pretty consistently through each month of the quarter.

Additionally, on the manufacturer cost side, we kind of matched it all the way through there as well, too. We really started to see positive price-cost as we got towards the middle of the quarter. I think we talked a little bit about the April numbers when we released last time.

We started to see positive price-cost within the May timeframe break even, and then to positive price-cost when we got to the June period. So you saw it improve, both the selling price as well as price-cost, each month of the quarter as we went through..

Okay. And then as it relates to Beacon versus the industry, I think the ARMA data suggested growth somewhere in the mid-single digits. And I understand that's not perfectly comparable to you as a distributor, but it sounded also like maybe there was some strength out East according to OC.

Can you just give us an idea? You normally would give us a geographic breakdown of existing market sales growth, and I don't think you did that in the slides this quarter.

Could you either give us those numbers or talk qualitatively about it?.

Yeah, Dave. It's really interesting. And that's why as we look at the quarter, of course, we don't feel good about where sales ended up in total, but when we look at the pieces, it's very clear to us what happened. We got price across every region, even where we lost volume.

Right? And in the East, our reported regions – the Northeast was up 23%, the Mid-Atlantic, close to 10%, the Southeast – this is resi now – the Southeast up 11%. So when you look at those – and Canada was flat, but they're a heavy commercial anyways – they were up 20% commercial year-over-year.

So when you look at those numbers, I mean, it says that we did extremely well against ARMA.

When you do look at ARMA and you look at the West, regardless of the state, whether it's for three months or six months, I mean, there's some big negative Vs (29:37) in this anywhere depending on the state and the size from 10% to over 20% delta, right? Which – we don't like to use ARMA close in, even six months, but as you look at it for six months and consider some of the activity from prior year, it makes us at least understand that we did fairly well against what the rest of that market is seeing.

That's our view, meaning hail legs slowed up. No new hail came in. I think everybody's in the same boat. So what did we do? We adjusted cost as quick as we could.

I think we did a pretty darn good job, and we continue to focus on these bigger growth elements that I talked about, that long-term will do just what we want them to do, and that's drive organic growth..

Hey, Dave, this is Joe. I didn't want to ignore your other question, so I wanted to come back to – you asked about the price-cost by line of business as well too. And my response there, just to give you some direction is we saw the same trends across each of the lines of business.

So that price-cost gap narrowed in each of our three LOBs through each of the three months in the quarter, pretty much the same way. I think it gets to our disciplined approach to pricing. We knew exactly across each LOB what the price increases were from the manufacturers.

We targeted our price increases to our end customers to match that accordingly through it, so we were able to keep them pretty consistent in terms of closing the gap in all three lines of business as we went through the quarter. It was our approach that accomplished it..

Sounds good, guys. Thank you..

Thanks, Dave..

Our next question comes from the line of Matt McCall with Seaport Global. Your line is open..

Thanks. Good afternoon, everybody..

Hey, Matt..

So maybe continuing on that last question, Joe, last quarter you gave kind of a roadmap of your expected price-cost trajectory through the rest of the year.

Can you update us on what that looks like in the Q4 guide? And maybe if we could take a step beyond your Q4 and get into calendar Q4, what do you expect that trajectory to be like through the rest of the calendar year?.

Sure. You bet. First, probably to your point, as we noted, great news on the price-cost. We were anticipating it to not quite be where we ended up this quarter.

We thought we would still be negative in the price-cost, but as I mentioned and as Paul mentioned in his comments, the teams did an excellent job of knowing what we needed to accomplish, communicating it effectively to our customer and to the marketplace and really driving that price into the market accordingly.

So it was a great effort by all of the teams in getting the price-cost. If I look forward to fourth quarter, your thoughts on the roadmap.

We expect to continue the same path we had, so our discipline in pricing, knowing the manufacturers' cost increases that are coming at us and also then, having our targeted price increases that go with it as well too. We also have the advantage of we have a little bit more inventory right now.

So we've got a good inventory position that will help us from a cost perspective. So we're confident in Q4 that we'll have the same relationship with price-cost as we did in Q3. So we expect it to at least be price-cost neutral, more likely very similar to what we had in the third quarter it was a slight positive on price-cost.

We expect those trends to continue..

Hey, Matt. And I'll just add, this is a great example of us using and being able to take a really good organization out of the Allied team, that pricing team, to help drive this because that group really jumped in, both systemically and from a leadership standpoint, to really help us drive price.

And as we've said all along is, if you take it up a notch, I mean, we believe inflation is good for distribution, but it has to get out into the channel, and we think we've helped enable that for the industry, and we're going to continue it. We're not going to back down..

We talked about....

Okay..

...the weekly due prices (33:48) in meetings, and in those, to what Paul described, we know in those meetings exactly what the manufacturing costs are doing going forward. We have projections of those, and therefore we know what the price needs to be as well too. That's what helps us be as disciplined in our approach..

Okay. Thank you, both. You mentioned some targeted cost reductions that you implemented.

Can you put some numbers behind that? Then what impact is that expected to have on SG&A? What's assumed in the Q4 guide? And then how does it layer in as we move out in the next fiscal year?.

Sure. As you've always known, being a lean operating cost structure and focused on continuous improvement has been one of the strengths we have. Bringing the Allied team aboard has helped us as well as that same approach, they have the same kind of philosophy with us now also. So it's been great.

As we entered the quarter, got past April, started see some of the softest in volumes, we really – everybody on the team jumped on board to say, all right, where do we need to get to? So we created a team to really go after trying to drive our initial target was roughly around the $20 million of cost out of the business, meaning looking at our existing operating expenses, how can we get $20 million out of it in terms of the short-term period here? So that's really our goal.

We have plans in place to get that $20 million out, probably not all will be out by the time we get to the end of the year. It'll help us as we get into next year as well too. But I think it's just the beginning of a continued or renewed focus on continuous improvement that you'll see here at Beacon as we go forward..

Thank you, Joe..

Our next question comes from the line of Garik Shmois of Longbow Research. Your line is open..

Hi. Thank you.

Maybe I missed this but I was wondering if you could talk a little bit about your level of pricing that you secured in some of the weaker hailstorm markets? And maybe talk to your confidence and able to continue to push price in what seems like a down volume environment, recognizing that the comps are difficult but I think there's a concern that if volumes continue to trend lower against difficult comparisons, that pricing might end up falling for the industry and for yourselves..

Yeah. And without going through every region, I can say that we were pretty successful at driving price and the impact that hail markets and in – we can't forget about the West Coast where they saw and started to see as they went through May, down volumes just because of the comps. And again, we thought the volume would run out longer for them too.

They did extremely well on price. And I think it's really a tribute to our relationship with our customer base, the strength of our offering in these dense markets, these MSAs where we have multiple branches, have fantastic people that service the contract or customer base that we've been able to achieve it.

I think moving forward, our view right now, and it's based as Joe alluded to in data and our process is that that's going to continue. Because our folks understand how much effort they put into getting price up, and they're just not going to back off. And we believe that our service offering is very, very strong.

Right? So as volume recovers, we're going to see more volume. I mean, that's all there is to it. And it's our customers, as we talk through it with them, they understand it. Yeah. So we feel pretty good about it, even in these weaker markets.

That's why think it's even more impressive that we drove the price we drove considering how weak the, in general, the West was, or at least these storm markets were..

Okay. Thanks. And then just my follow-up is just on inventories.

Just the increase in the quarter that you mentioned, it was in line with seasonality, but just any more color on how you're expecting to drive down inventories given the volume environment and how you expect to be positioned going into fiscal 2019?.

Certainly. This is Joe.

One thing to keep in mind is that the increase in inventory, which if you – if we were try to – as we analyze that and incorporating where Allied was before, so trying to look at a combined company with Allied last year versus this year, we are up a couple hundred million dollars in inventory, but almost half of that number is really from price.

As you know, with the inflation our input costs are up. So a good driver of why our inventory value is up have to do with price, almost half of it. Then you've got some within the storm markets like Florida is driving another substantial piece of it.

And the remaining part is, what I had mentioned, is a little bit of a buy ahead in inventory to help to position us well as we go into the fourth quarter. As always, you see a significant push from us in driving inventory levels down through the fourth quarter.

So don't be surprised to see them come down pretty dramatically as we go through the quarter. We'll take advantage of the inventory levels we have and they'll help with our shipments and, obviously, in our gross margins as well, too..

Our next question comes from the line of Trey Morrish with Evercore. Your line is open..

Thanks, guys. So, you talked about how you saw weak demand out in your Western region. And looking at the ARMA state level data, we can see that California, Nevada, down 20%; Arizona, down 10%.

Could you talk about what share of your business actually takes place in dollars out in the West, potentially also in Texas, because that state has also seen a fairly noticeable drop-off in demand as well?.

Yeah. We typically have not broken out sales by those geographies. I can tell you that most of those impacted areas we have share above our normal company share rate, which is in the low 20s, right? So, that should give you a good indication.

So whether it's Texas, Colorado, Missouri, Kansas, even in California, we have relatively high share levels there. And we did quite a good job, and we always do, as demand is high, right? So conversely, as there's a trough, like we're seeing right now, there's the drop. But again, we know we'll also rebound..

Okay. And then you mentioned synergies, about $25 million year-to-date, implying about $13 million were realized in the third quarter. How does that – or sorry, $19 million in the third quarter.

How does that split between gross margin and what showed up in operating costs?.

Yeah. The bulk of it's in the operating expense piece, but we started to see some flow through the cost of goods sold section as well, too. The breakdown was – looks like we had – it was almost split evenly between the SG&A part and the procurement piece of it, actually.

When I look at the results for the quarter, you had a nice mix of where we started to see the synergies from the procurement piece to start to roll on through. So it was almost split evenly between procurement and the SG&A side.

And the SG&A side is a combination of the consolidations of branches which were starting to occur, combined with the SG&A which is a lot of the head count savings that we have..

All right. Thanks very much, guys..

You bet..

Thank you..

Our next question comes from the line of Jay McCanless with Wedbush. Your line is open..

Hey. Good afternoon, everyone. Thanks for taking my questions. So, the first question I had, if I look at the guidance that you guys gave for 2018 on the fiscal 4Q 2017 call and compare it to where it is now, basically the revenue midpoint looks like it's down about 4%, but the adjusted earnings guidance is only down about 2%.

I guess, what has happened during the course of the year that made you more positive on where you thought the year would go from 1Q to 2Q, but seems to have reversed itself so quickly? And I guess maybe a different way to ask it is, how much of this change in the revenue guidance is related to weather that didn't happen that you maybe expected versus maybe a loss of share to some other competitors?.

Yeah. We look at this, we track customers, we track progression of customers in every region. And we do firmly believe this is related to what's happened with the weather. Now again, getting back to why were we positive? We had a relatively clear path as we looked through the year, even as we went through April.

And as we looked at those storm markets, we thought, hey, there's another four to six months plus of activity that's going to be completed. And in addition, we did put in – there is normalized storm volume. And what happened was – it's very difficult to predict all this, even though we've been through this a number of times.

And what happened was the work dried up, got done quicker. Some of it has to do with our share size; some of it has to do with large contractors moving into the storm areas.

And then there was no – as I said earlier, virtually no hail damage, wind damage, any damage in any of those areas, and even California, where they had pulled forward because of rain in prior periods. So, that's kind of the reason why. In terms of share loss, one, share is very difficult to predict. I talked a little bit about ARMA prior.

But we do not believe in any of those markets we're losing share, because if you look at even the East Coast where we're seeing very strong volume, we're getting the same relative price penetration, and that's because it's a strong market; or in Florida, where we're really seeing strong volume. Joe, I don't know if you have anything to add, but....

Nope. I think that covers it. The other half of your question was around the relationship between our revenue decline relative to a smaller amount of our earnings decline. And you're right, we're seeing more favorable improvement on gross margins and OpEx.

So that's what's getting us more optimistic on why the bottom-line number is not declining as much as the top-line number, as you had mentioned.

Our gross margin improvement, price-cost coming in quicker than we thought, all the great work from the teams, as we described, cost control coming in better than we thought, as Paul mentioned, it's really the top line, and it's really weather..

Okay. And then the second question I had, I believe you said earlier that for all three lines of business you saw price-cost improve through the quarter, and you saw, I believe you said, unit volumes improving as well.

But the one thing I wanted to ask, in terms of the inside the house business – or what type of, I don't know, market pressure, competitive pressure – what are you seeing from competitors there? And are you maybe feeling it a little bit harder on the volume side there than you do in your traditional outside of the house business?.

Yeah. Our interior business – again, we don't break out that portion of our business in any great detail. It's doing quite well. Growth is solid, considering we achieved positive price-cost and EBITDA margins are strong. So that's been a very consistent performer for us.

So other than the normal regional competitive challenges you would see in any market, the interior business is running quite well..

Very stable business, as Paul had described on the price-cost side. Little bit less kind of price increase that you see in regards to the drywall side of it, so not as much as roofing segment piece. But we've done a great job. The teams have done a great job of kind of passing that through..

Thanks for taking my questions..

Thank you..

Ladies and gentlemen, our final question comes from the line of Trey Grooms with Stephens, Incorporation. Your line is open..

Hey. Good afternoon, gentlemen.

So really my questions have mostly been asked, but I think on the last round of questions there, in your efforts in getting price-cost neutral and now positive, you guys had implemented some new strategy or some of the new pricing kind of going to market the way that I think that Allied had more of an approach in that direction of – I don't know if it's more centralized or less.

I don't know how you classify it, but there was some – a change on that focus, I think, that you guys were rolling out.

Where are we there? And is that impacting the price benefits you're getting here?.

No. We still have extremely talented people at that branch level, whether it's branch manager, district manager, outside sales, inside sales that had an awful lot to do with pricing. My comments earlier referenced Allied with the fact that they've had a very, very good pricing approach. I wouldn't call it centralized, but they do offer a lot of advice.

And in terms of as we went through changing all the pricing profiles, raising price in every market, making sure we're at the right pricing levels, that team helped our field execute the real work, not that the legacy Allied team didn't do real work, but our folks had to talk to customers, right, and convince them of the change, go through that whole process.

So I think longer term, we'll still have an awful lot of control because we have to because we're a decentralized company. And we have great people in the field, but what we'll have is an added layer of analytics that'll come out of the headquarters group to help shape pricing, help the field make better decisions with pricing, et cetera.

That's really what we've just begun, and they were a big help as we went through these last four, five, six months..

Okay. Thanks for that. And then, lastly is on the hub-and-spoke type rollout, Allied has more of a footprint, or more of their footprint is tied to kind of hub-and-spoke. I know it's part of the strategy is kind of rolling some of that out to Beacon branches and further out into Allied.

Where are we in that process and the outlook for, kind of, achieving that over the next year or so?.

Yeah. We've really just started rolling that out in a couple of selected markets that I won't mention, mostly, right now with centralized dispatch. That'll be vetted as we go, or rolled out, rather, over the next 12 to 18 months in many more MSAs. And you'll hear more about it as we go through time..

All right. Thanks for taking my question..

Thanks, Trey..

Thanks, Trey..

Ladies and gentlemen, due to time limitations, that concludes the questions. Now, I would like to turn the call back over to Mr. Isabella for closing comments..

Yeah, thanks, and I'll be brief. I just want to thank everybody for participating in today's call. And as always, we appreciate the interest in Beacon from the investment community. We want to express our appreciation to our customers and to our valued suppliers, and of course, our employees.

And we look forward to speaking with many of you again in the coming days and, of course, in the next release. Thanks, and have a great evening..

Ladies and gentlemen, thank you for participating in today's call. You may now disconnect. Everyone have a great day..