Ferguson Enterprises Inc. (FERG) Earnings Call Transcript & Summary

Good day, ladies and gentlemen. My name is Justin, and I will be your conference operator today. At this time, I would like to welcome you to the Ferguson plc IFRS to U.S. GAAP Investor Session. [Operator Instructions] This call is being recorded. A presentation accompanying today's investor session is available on Ferguson plc's website. Any GAAP financial information or non-GAAP financial information discussed today is unaudited and should be considered preliminary and subject to change. The presentation contains other information about non-GAAP financial measures, including a reconciliation of such measures to their most directly comparable measures presented in accordance with GAAP. In addition, some of the statements today, both in the prepared remarks or in answer to questions, may be forward-looking, including within the meaning of the United States Private Securities Litigation Reform Act, and are subject to certain risks and uncertainties that could cause actual results to differ materially, including those noted on Slide 2 and in the Form 20-F filing with the SEC. Other than in accordance with legal or regulatory obligations, Ferguson undertakes no obligation to publicly update or revise any forward-looking statements. At the end of the prepared remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the call over to Mr. Brian Lantz, Ferguson's Vice President of Investor Relations and Communications. You may begin your conference call.

Thank you, operator. Good morning, everyone, and welcome to Ferguson's IFRS to U.S. GAAP Investor Conference Call and Webcast. With me on the call today are Bill Brundage, our CFO; Rich Winckler, our Chief Accounting Officer; and Pete Kennedy from the IR team. I will now turn the call over to Bill to set out the broader context of this change.

Good morning, everyone, and thank you for joining us on the call today. As we discussed at the half year results in March, the group will be adopting U.S. GAAP reporting at the start of our new fiscal year beginning on August 1. This is the next logical step in our journey as we focus our operations on our attractive North American markets. The principal rationale for this change in reporting is to facilitate better comparability to U.S. peers, partly through using the same accounting basis, but also through use of more closely aligned KPIs, which we will outline on the call today. With that, I'd like to introduce you to Rich Winckler, our Chief Accounting Officer, who will walk us through the impact on the financials.

Thanks, Bill, and good morning. Let me start with a high-level overview of the primary accounting differences between IFRS and U.S. GAAP as it relates to our alternative performance measures as well as our income statement. As you are aware, our primary alternative performance measures under IFRS are gross margin, underlying trading profit and headline earnings per share for fiscal '22. And with the transition to U.S. GAAP, we will change our alternative performance measures as outlined in our headline results summary. Gross margin. There are no differences between IFRS and U.S. GAAP impacting our calculation of gross margin. Underlying trading profit. Underlying trading profit will change to adjusted earnings before interest and taxes or adjusted EBIT, which will include acquisition-related intangible amortization, but exclude exceptional or nonrecurring items. We will also continue to report adjusted EBITDA, which adds back noncash amortization and depreciation. Headline earnings per share will also change as we transition to U.S. GAAP. The primary differences between our headline earnings per share under IFRS compared to U.S. GAAP are as follows: we will include the impact of acquisition-related intangible amortization, net of tax, which is consistent with our pretax alternative performance measure of EBIT as previously noted. U.S. GAAP earnings per share will focus on the diluted measure, which generally includes, in the denominator, the impact of unvested stock-based compensation awards. This is compared to IFRS, which focused on the basic calculation, which generally excluded these items. In addition to providing a revised view of our headline results summary, we have also provided a bridge of IFRS trading profit to U.S. GAAP adjusted EBIT and adjusted EBITDA. The bridge outlines the primary accounting differences between IFRS and U.S. GAAP, which relates to lease accounting. Under U.S. GAAP, since most of our leases are deemed to be operating leases, lease expense generally equals our rental charges recognized on a straight-line basis. IFRS split lease expense by recognizing a portion as interest expense. With that said, since we have been reporting underlying trading profit, which generally treated lease expense similar to U.S. GAAP to differences between underlying trading profit to adjusted EBIT come down to the inclusion of acquisition-related intangible amortization and, to a lesser extent, some smaller accounting differences related to stock-based compensation. From an overall income statement perspective, we've set out the key principles on this slide for your reference, but I will move over to the income statement view in order to walk you through the numbers. As you can see, there are no impacts to revenue or gross profit. And therefore, as previously noted, there is no impact to gross margin between IFRS and U.S. GAAP. The primary income statement impacts arise from lease accounting differences with lease costs going into operating costs and coming out of finance costs. Aside from lease accounting, there are some minor differences in stock-based compensation expenses and pension expenses between IFRS and U.S. GAAP. Again, from a balance sheet perspective, we have set out the key principles for your reference. The primary balance sheet impacts are generally in the presentation and ordering of assets and liabilities under U.S. GAAP compared to IFRS. U.S. GAAP will present assets and liabilities in order of liquidity with cash at the top of the balance sheet. The balance sheet presentation of leases is generally the same under both IFRS and U.S. GAAP as the lease accounting impacts are more centered on the income statement as previously noted. On this slide, we have bridged from the fiscal '20 IFRS balance sheet, removing the disposed U.K. business and showing the U.S. GAAP adjustments. I'll run down some of the larger figures here. Intangible assets increased slightly due principally to historical differences in the treatment of goodwill amortization. Software assets of $141 million have been reclassified from intangible assets into property, plant and equipment. There are some differences in how these asset values are recognized. So under U.S. GAAP, the right-of-use assets increased by $240 million. Trade and other receivables will now be split into 3 new headings. Moving over to the liability side of the balance sheet. Trade and other payables is also split into 3 new headings under U.S. GAAP and the $74 million uplift in deferred tax is principally due to the increase in the right-of-use assets recognized under U.S. GAAP. From a cash flow statement perspective, there is no economic change to cash flows or ending cash balances as a result of the conversion. Similar to the balance sheet, the primary cash flow statement impacts are generally presentational matters related to the presentation of lease payments, which are presented in operating activities for U.S. GAAP compared to financing activities for IFRS. In addition, there are also cash flow presentation differences related to bank overdrafts, which are not included as part of the open or closed cash position under U.S. GAAP. We have included a full U.S. GAAP cash flow within the appendix for your reference. As we look at the EPS metrics, you can see that the differences between IFRS and U.S. GAAP are very minimal. The primary difference is that we now use adjusted net income, which is post amortization of acquired intangibles and aligns our EPS metric with the new EBIT profitability metric. Also, as I mentioned earlier, the U.S. GAAP earnings per share were focused on the diluted measure which includes the impact of unvested stock-based compensation awards in the denominator. From a return on capital employed perspective, consistent with the previous remarks regarding the change to EBIT, we will be using EBIT as our numerator as adjusted for exceptional items and inclusive of acquisition intangible amortization. In addition, EBIT will be calculated on a continuing operations basis. Regarding the average capital employed, we will include the leased assets and liabilities that are recorded on the balance sheet as well as the accumulated acquisition-related intangible amortization. So effectively, the denominator is equity plus net debt. In summary, the primary impacts from the transition to U.S. GAAP relate to the treatment of lease expense within the income statement and the inclusion of acquisition-related intangible amortization and our U.S. GAAP alternative performance measures. Balance sheet and cash flow statement impacts are minor overall and impacts are generally on presentational matters. Thank you. And now we would be happy to take any of your questions. Operator, let me hand back the call to you.

[Operator Instructions] And our first question will come from James Rose with Barclays.

I've got 2. I think the first one is on sort of within your working capital. Are there any accounting policy changes? So I think the U.S. GAAP will allow for different policies than IFRS would. Have you changed anything at all? And then secondly, I mean, very broadly, does any of this impacts the way you run the business in any sense at all?

And again, speakers, perhaps you placed yourself on mute. Go ahead, please.

Seems like the team have got some technical difficulties at the moment. So James, it's Pete Kennedy from the IR team. There is no impacts on how we will run the business based on these changes. It is purely presentational. And in terms of working capital then, there is no impact on how we recognize those balances. We have split trade receivables and trade payables into 3 distinct buckets, respectively, so there'll be a bit more clarity there for you.

And our next question will come from Keith Hughes with Truist.

Two questions. Will you be reporting -- the fiscal year-end July, will you be reporting that in GAAP or will it be under international standards or a combination of both? And then second question, will you start, I guess, in fiscal '22 reporting quarters with full financial statements for quarters?

So Keith, yes. In FY '21, we will report under IFRS but we will give the breakdowns of the U.S. GAAP numbers. So you will have the full fiscal '21 figures to go from. And then as we step into fiscal '22, we will provide breakdowns under U.S. GAAP, but we won't be doing 10-Qs and 10-Ks at this point. So it won't be -- it will be similar to how we've done it in the past, but under U.S. GAAP rather than full 10-Qs.

And our next question will come from Arnaud Lehmann with Bank of America.

Two questions on my side. Firstly, the decision to go for adjusted EBIT rather than underlying trading profit. So I'm assuming this is purely to be consistent with the reporting of your peers because I would think [indiscernible] always better to have bigger numbers and bigger margins than the lower one. So I guess the 7.4%, the restated margin at EBIT level, is the one that will be more consistent with your U.S. peer going so on. That's my first question. And secondly, slightly unrelated to that, but I know you were thinking at one point post U.K. disposals to give a bit more granularity in terms of your reporting considering now that you've been now running the U.S. and Canada. Have you -- are you taking this opportunity to increase the number of line in reporting so we have a bit more than just sales and adjusted EBIT for the U.S. business, in particular?

So in terms of adjusted EBIT, we feel that EBIT is the best measure of profitability for our business and is entirely consistent with many peers. We will continue to report adjusted EBITDA as it feeds into our leverage calculation and it's actually very useful to our shareholders. In terms of the segments of the business then, we run our U.S. business with combined functions. So we run that U.S. business as one unit. So we will continue to retain the segments of U.S. and Canada.