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Edited Transcript of BLDR earnings conference call or presentation 1-Nov-19 2:00pm GMT

Q3 2019 Builders FirstSource Inc Earnings Call DALLAS Dec 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Builders FirstSource Inc earnings conference call or presentation Friday, November 1, 2019 at 2:00:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Binit Sanghvi Builders FirstSource, Inc. - VP of IR * M. Chad Crow Builders FirstSource, Inc. - CEO, President & Director * Peter M. Jackson Builders FirstSource, Inc. - Senior VP & CFO ================================================================================ Conference Call Participants ================================================================================ * Alexander John Rygiel B. Riley FBR, Inc., Research Division - Analyst * James A. Morrish Evercore ISI Institutional Equities, Research Division - Analyst * John Allen Baugh Stifel, Nicolaus & Company, Incorporated, Research Division - MD * Keith Brian Hughes SunTrust Robinson Humphrey, Inc., Research Division - MD * Kurt Willem Yinger D.A. Davidson & Co., Research Division - Research Associate * Matthew Adrien Bouley Barclays Bank PLC, Research Division - VP * Matthew Schon McCall Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst * Megan Talbott McGrath The Buckingham Research Group Incorporated - Director * Michael Glaser Dahl RBC Capital Markets, Research Division - MD of U.S. Homebuilders & Building Products * Trey Grooms Stephens Inc., Research Division - MD ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good morning, and welcome to Builders FirstSource's Third Quarter Conference Call. (Operator Instructions) Today's call is being recorded and will be available at www.bldr.com. It is now my pleasure to introduce Mr. Binit Sanghvi, Vice President, Investor Relations. Please go ahead. -------------------------------------------------------------------------------- Binit Sanghvi, Builders FirstSource, Inc. - VP of IR [2] -------------------------------------------------------------------------------- Thank you, Shantel. Good morning, and welcome to the Builders FirstSource Third Quarter 2019 Earnings Conference Call. With me on the call today are Chad Crow, Chief Executive Officer; and Peter Jackson, Chief Financial Officer. A copy of the slide presentation referenced on this call is available on the Investor Relations section of the Builders FirstSource website at bldr.com. Before we begin, let me note that during the course of this conference call, we may make statements concerning the company's future prospects, financial results, 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 no obligation to publicly update or revise any forward-looking statements. The company will discuss adjusted results on this call. We have provided reconciliations of non-GAAP financial measures to their GAAP equivalents in our earnings press release and detailed explanations of non-GAAP financial measures in our Form 8-K filed yesterday, both of which are also available on our website. I will now turn the call over to Chad Crow. -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [3] -------------------------------------------------------------------------------- Good morning, and thank you for joining us. I will start on Slide 2. Our team delivered an impressive performance in the third quarter, building on our year-to-date progress to produce above-market growth, expand margins and generate outstanding cash flow. I'm proud to say that we recorded the 13th straight quarter of year-over-year increases in adjusted EBITDA and achieved an EBITDA margin of 8.1% of sales, our highest quarterly percentage since our 2015 acquisition of ProBuild. Our ongoing strategic investments and market-leading value-added products capacity has provided the targeted growth margin and customer value benefits we anticipated. Our operational excellence initiatives also continue to gain momentum and are contributing to our results. And notably, our strong cash flow and working capital management continue to fund our investments, which included an acquisition of 3 strategic truss manufacturing plans and further paydown of debt. We were especially pleased to achieve the low end of our long-term targeted ratio of net debt-to-adjusted EBITDA of 2.5x as of the end of the quarter. We believe our success is a direct result of our commitment to our strategic initiatives. Our momentum in sales volume during the quarter continued from the strong first half of 2019, supported by an improvement in our -- in all of our end markets. For the first 9 months of the year, sales volume, excluding commodity deflation, grew by more than 6%. Once again, our value-added product categories led the volume growth increasing in sales volume by an estimated 9% in the first 9 months as we continue to realize the benefit from years of strategic investments. Commodity deflation negatively impacted sales by nearly 13%, which led to an overall decline in reported sales of 7%. Despite the headwinds, we grew adjusted EBITDA by 8% compared to the same year-to-date period last year, thanks largely to our team's focus on executing our growth strategy that drove a 300 basis point improvement in gross margin percentage. Our operational excellence initiatives continue to have a positive impact on our results. As mentioned on our previous calls, we are executing upon key initiatives with specific action plans in 4 key areas: enhanced business analytics, pricing management tools, our My BFS Builder customer portal and delivery optimization technology. During the first 9 months, we saw the benefit of these initiatives, especially with our pricing tool implementation and delivery optimization platform, which has improved our distribution network in terms of speed, uptime and reliability. At the same time, we have laid the groundwork to enhance efficiency in other areas, such as on-time delivery and inventory management, which Peter will discuss in more detail. We remain on track and expect a benefit of between $14 million and $16 million to our adjusted EBITDA in 2019 from these initiatives. Our market-leading network of value-added offsite component manufacturing facilities has positioned us well to meet the growing demand from homebuilders for productivity and efficiency in the face of ongoing increases to labor cost and scarcity. In July 2019, we expanded our presence to the Las Vegas and Phoenix markets by purchasing 3 truss manufacturing facilities. Our ongoing organic investments also continued during the quarter, and we are on track to have 2 new greenfield truss plants and approximately 8 new truss lines in existing plants by year-end. In addition, we are investing in door, facility expansions as well as new machinery and systems, and a dozen more of our value-added operations. We will continue to invest in expanding our industry-leading production capacity, sales force and distribution network. Our commitment to broadening this competitive advantage is what has led to our above-market growth and outstanding track record of performance. I will now turn the call over to Peter, who will share our third quarter financial results in more detail. -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [4] -------------------------------------------------------------------------------- Thank you, Chad. Good morning, everyone. I'm especially proud of our team's work in delivering another quarter of improvement in the controllable aspects of our business. We achieved $2 billion in net sales in the third quarter, down 6.5% versus the prior year period. We had 1 additional sales day in the third quarter of 2019 compared to the prior year quarter, so I will speak to our sales drivers on a sales per day basis for better comparability. Net sales per day declined by 8% due to commodity deflation, which decreased sales by an estimated 17.4%. The commodity headwind masked robust sales volume growth of 9.4%, a rate significantly above the overall U.S. starts market. The largest contributor to this growth was, once again, our value-added product categories, which increased 11% over the third quarter of 2018, reflecting the ongoing execution of our strategic plan. Gross margin of $541.1 million increased by $18.4 million or 3.5% over the prior year. Our gross margin percentage increased to its historical high at 27.3%, representing a 260 basis point improvement compared to the same period a year ago. The margin percentage increase was attributable to several factors, including an improved product mix as our team continued to maintain focus on delivering higher margin, value-added solutions to our customers. Additionally, the decline in the cost of commodities, along with our team's continued focus on pricing discipline, contributed favorably to gross margin. In regards to pricing and commodity costs, as we have discussed on prior calls, market cost inflation causes short-term gross margin percentage compression when prices rise rapidly relative to the short-term pricing commitments we provide customers. We experienced this temporary contraction during the third quarter of 2018. Conversely, gross margin percentage expansion occurs when costs rapidly decline. This quarter, commodity prices dipped a bit lower before recovering to levels in line with the beginning of the quarter. As a result, we believe the tailwind that we have experienced for most of 2019 has concluded as commodity prices remain stable, which we expect will return gross margin percentages to more normalized levels in the fourth quarter. Our SG&A as a percentage of sales increased by 190 basis points on a year-over-year basis driven largely by the impact of deflation on sales. In addition, strong volume growth and higher gross margin led to higher variable compensation in the quarter. As we have mentioned in prior quarters, our incentives increase as our sales team achieves higher margins. Accordingly, our strong gross margin percentage gains more than funded the higher commission expenditures in the quarter. Interest expense for the quarter was $27.8 million compared to $29.1 million in the prior year, a decrease of $1.3 million. Excluding a $3.1 million charge related to a debt financing transaction executed in the third quarter of 2019, interest expense declined by $4.4 million largely due to lower outstanding debt balances. During the quarter, we issued an additional $75 million in notes that mature in 2027. The net proceeds were used to repay a portion of our 2024 notes. This is another step in prudently managing our balance sheet by extending existing maturities while simultaneously reducing our overall leverage ratio. Adjusted net income for the quarter was $84 million or $0.72 per diluted share compared to $77.8 million or $0.67 per diluted share in the third quarter of 2018. The year-over-year increase of $6.2 million or $0.05 per share was primarily driven by the improved operating results, combined with lower adjusted interest expense. Third quarter EBITDA grew by $5.5 million or 3.5% to $160.3 million, the highest in our history, driven by the growth in gross margin mentioned previously. Turning to Slide 4. The strength of our business, driven by our national scale and strong local customer relationships, was again evident in the third quarter results as U.S. housing starts improved. Our team grew net sales across our value-added and noncommodity-related product categories. Excluding deflation, our lumber and lumber sheet goods product category also achieved solid growth in estimated sales volume. We are committed to the expansion of our component manufacturing network strategically located across the country. We continue to build upon the strength of our existing network. And as Chad mentioned, we are pleased to have added Sun State Components to the Builders FirstSource family, along with its 3 additional truss manufacturing facilities, bringing our total to 61. Turning to Page 5. Our third quarter sales volume per day grew over 9% in the single family new construction end market compared to an increase of 4% in overall U.S. single family starts. Regional strength in parts of the East, an improvement in Texas as well as the Pacific Northwest contributed to our outperformance. A common thread throughout all parts of the country is that we grew value-added products across our footprint. Our sales volume in R&R and Other end markets increased by 11% driven by solid home improvement activity in Southern California. Multifamily sales volume improved by 5.8%, largely due to the timing of projects compared to the prior year. Turning to Page 6. I'll first point out that we now define free cash flow as cash provided by operating activities, less purchases of property, plant, and equipment or CapEx. This quarter, we have updated the metric to exclude acquisitions and other cash investments for better comparability to peers and to more clearly delineate between our discretionary free cash flow and our strategic capital allocation priorities. For the first 9 months of 2019, we have generated $282 million in free cash flow, representing well over 100% of adjusted net income. Although our business typically uses cash in the first half of the year and generates cash in the second half due to seasonal working capital needs, the exceptionally strong cash flow performance so far in 2019 is due to the impact of commodity deflation and our operational excellence initiatives driving working capital improvements. We continue to allocate our capital to strategic priorities, which include growing our value-add capacity, funding strategic acquisitions and further improving our balance sheet to generate shareholder value. We remain on track to invest approximately 25% of our total 2019 capital expenditures in our value-added growth initiatives and expansion of our production capacity. During the third quarter, we funded our acquisition with approximately $34 million in cash. We were especially pleased to make these investments, while at the same time, preserving ample liquidity and further improving our net leverage ratio. At quarter end, our net debt to trailing 12-month adjusted EBITDA ratio was 2.5x. This represented a 1.4x reduction from the prior year quarter and at the low end of our target range of 2.5 to 3.5x, improving the strength of our balance sheet and providing capacity and flexibility for future business developments and M&A. Moving to Slide 7. The rollout of our operational excellence initiatives is driving greater working capital efficiencies through our disciplined framework designed around systems, tools and processes that are directly aligned with our cash flow performance objectives. A key catalyst here is that these initiatives are not only a benefit to Builders FirstSource but also significantly benefit our customers. For example, the implementation of our delivery optimization systems improves the reliability and efficiency of our outbound logistics network while minimizing transport and storage costs. By ensuring efficiency throughout the distribution process, we improve inventory days through higher turns and reduced cycle times. Our customer also benefits from increased on-time delivery, which, in turn, drives higher satisfaction rates. Similarly, adoption of our customer portal, My BFS Builder, is supporting increased online payments allowing for faster and more efficient cash collections. While this achieves faster cash collections for us, customers also receive the benefit of having 24/7 access to key business information like orders, deliveries, invoices and statements. The speed, benefit and convenience of the portal are perfectly aligned with the dual goal of efficient capital management and enhanced value to the customer. Our approach is systematic, and plans to achieve these improvements are measurable. Implementation is rooted in changing the process, routines and tools used across our 400 locations. We have regular progress checks to ensure successful execution and that the improvements are sustainable. This includes annual targets, monthly follow-ups, training and corrective action plans as needed. Above all, performance towards achieving the desired results are directly tied to compensation at the local level in order to provide the proper alignment of incentives. Approximately 60% of our locations have working capital improvements this year, and we expect working capital as a percentage of sales to improve by approximately 1.4 percentage points in 2019, contributing to incremental free cash flow. We are demonstrating success at implementing structural changes throughout our organization, consistent with our long-range plans to achieve sustainable cash conversion improvement as we grow net income. Moving to Slide 8. Looking forward to our fourth quarter and full year 2019 expectations, we remain confident in our team's ability to execute on market opportunities, mitigate commodity cost dynamics and deliver on the initiatives within our control. We expect fourth quarter net sales per day to decrease between 2% to 5% over the prior year driven predominantly by the impact of commodity price deflation of between 7% and 10%. Gross margin is anticipated to be down 50 to 70 basis points versus the fourth quarter of 2018 as we return to a more normalized margin. Fourth quarter adjusted EBITDA is expected to be between $100 million to $110 million, supported by continued focus on cost discipline and efficiency improvements. We expect an effective tax rate in the fourth quarter, slightly below our long-term guidance of 24%. For the full year, we anticipate adjusted EBITDA to be in the range of $507 million to $517 million. Capital expenditures are on plan and expected to total approximately 1.5% of full year sales. Regarding cash taxes, we expect to be a federal cash taxpayer again in the fourth quarter of 2019. Cash interest and interest expense are both expected to be approximately $100 million. As we compete -- complete our systems integration work to support our operational initiatives, we expect onetime costs of $15 million to $20 million for the year. Consistent with our previously discussed definition, we expect our full year free cash flow to be in the $300 million to $320 million range. Now Chad will provide an update regarding our strategic priorities and outlook. -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [5] -------------------------------------------------------------------------------- Thank you, Peter. As we enter the end of the home buying season, the overall market outlook continues to improve. Homebuilders are increasingly catering to demands of buyers with a more affordable and right-sized product. Our market-leading investments in value-added products and ongoing growth initiatives enable us to provide productivity solutions to help our customers meet the changing demands of homebuyers. In this environment, we are confident that we can continue to -- continue our positive momentum to generate growth in our fourth quarter sales volume in the mid-single-digit range, led by single-family activity. Moving to Slide 9. Based on our meaningful progress to date against our longer-term targets, we remain confident that our unmatched scale, market diversity and value-added product leadership provides us with substantial opportunities to generate strong returns in our business. Our value creation framework begins with capturing incremental benefits from core business growth as the fundamentals of homebuyer demand remain intact and starts to continue to move towards historical averages. In addition, customers are accelerating the adoption of our labor, labor saving, high-efficiency, value-added products, providing significant ongoing opportunities to increase our market share. To meet this demand, we will continue to invest in value-added product facilities. The execution of this plan can be seen in our results with the 5 additions we are making this year. We see the market opportunity for these higher-margin products only increasing as customers recognize the value of these -- the value these products provide and accelerate their adoption. As we discussed today, our value creation plan also includes a set of operational excellence initiatives that are well underway. This includes the rollout of our distribution and logistics software, pricing and margin management tools, back office process efficiencies and information system enhancements. When fully rolled out across our roughly 400 locations, these initiatives and operational excellence and value-added products are designed to deliver cost benefits and margin expansion. Equally important, we will further differentiate our service levels and strengthen our connectivity and overall value proposition with our customers. The execution of our long-term value creation plan, combined with favorable demand tailwinds, puts us on track to achieve our goal of $200 million to $270 million in incremental EBITDA, representing a 50% increase as compared to the full year 2018 as housing starts reach historical averages. This translates to EPS between $3 and $3.50. Our focus on cash will remain a key to delivering shareholder value, and we intend to sustain greater than 85% conversion of our adjusted net income to free cash flow. The substantial cash we generate will be used to fund both our high-return growth investments and to further improve our financial flexibility. Our national footprint, unmatched manufacturing scale and exceptional sales force provides us with a platform to capture a larger share of the growth tailwinds in the coming quarters and years. Together with our ongoing investments in operational excellence and value-added capabilities, these strategic initiatives continue to give me confidence that we will achieve our goal. More broadly, I am confident that our disciplined strategic execution and implementation of these systems, tools and processes, has created a durable platform that will allow us to consistently create value for our customers and shareholders. I would especially like to thank our 15,000 team members across the country for their hard work and the part they each played in achieving our record profitability. Operator, we can now open the call for Q&A. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) Now our first question will come from Trey Grooms, Stephens Inc. -------------------------------------------------------------------------------- Trey Grooms, Stephens Inc., Research Division - MD [2] -------------------------------------------------------------------------------- Congrats on a good quarter. -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [3] -------------------------------------------------------------------------------- Thank you. -------------------------------------------------------------------------------- Trey Grooms, Stephens Inc., Research Division - MD [4] -------------------------------------------------------------------------------- And the outlook here for the 4Q, also equally impressive. And looking at the gross margin guide that you've given us here, 26.4% to 26.6%, I think, Peter, you mentioned that a lot of the tailwind from commodity, commodity price deflation has concluded, and you expect it to normalize in the 4Q. So is this 26.4%, 26.6%, is that kind of the -- I'm sure it's a lot closer, but is that the normalized gross margin we should be targeting there? Is there any -- anything else going in there that might be helping it out? -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [5] -------------------------------------------------------------------------------- Well, we'd certainly have seen very stable commodity prices over the last few quarters. So it'd be disingenuous to talk about the near-term impact of deflation as it relates to our pricing commitments. What we have seen that I think is important to note is this sense that there is value in the delivery of the product in the commodity side. And then that has paid off with slightly higher margins as the value has declined. So I think there's been some stickiness to a little bit of those higher margins, probably a bit more than we anticipated. We think we'll still stay above 26%, but I think there's room for that to drift down a little bit as we go into the upcoming year and years. But we certainly feel good about Q4. -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [6] -------------------------------------------------------------------------------- Then -- and I'll just add, Trey, that we've seen a little bit better expected results in our pricing initiatives that are part of the operational excellence initiatives. So that's been really good to see as well and is contributing to some of that. -------------------------------------------------------------------------------- Trey Grooms, Stephens Inc., Research Division - MD [7] -------------------------------------------------------------------------------- Great. Great. Okay. And then just for clarity, you changed how you calculate free cash flow, I think you made a mention of that. But the free cash flow that you're guiding to for full year, the $300 million to $320 million. Is that -- how does that compare to the prior goals that you had set maybe in the kind of -- I think it was $180 million to $210 million. How does that compare relative to the prior number? Or maybe is it -- I guess, how does the calculation compare? Is it the same or is it different? -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [8] -------------------------------------------------------------------------------- It is clearly an increase. When we talked about it last time, we were around that $200 million range. Accounting for the money that we were anticipating or that we had announced we were going to invest in Sun State Components. So there were $34 million of M&A, plus the $200 million. We were about $234 million, pretty substantial increase, obviously, from that point. We've continued to see strong results in our working capital initiative, and we've not seen a bit of the recovery in the pricing of lumber commodities that we thought would happen. So I think for the year, we're absolutely calling up cash. -------------------------------------------------------------------------------- Trey Grooms, Stephens Inc., Research Division - MD [9] -------------------------------------------------------------------------------- Got it. Okay. So that's the -- that's kind of the comparable number, the $234 million roughly is kind of the comparable number to the $300 million to $320 million? -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [10] -------------------------------------------------------------------------------- Yes. -------------------------------------------------------------------------------- Trey Grooms, Stephens Inc., Research Division - MD [11] -------------------------------------------------------------------------------- Okay. Perfect. Well, that's pretty awesome. So looking at -- last thing for me before I pass it on. You've got the leverage now at 2.5x at the low end of the range. So does -- should we expect maybe a pickup in M&A since you're kind of at the low end? Or a pickup in maybe pushing to accelerate a little harder in greenfields? And maybe the outlook for greenfields in '20 is kind of a lead on to that, too. -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [12] -------------------------------------------------------------------------------- Well, I'll answer the M&A side. There's a lot of opportunities we're seeing out there right now. So I guess the answer would be, yes, it does clearly give us more financial flexibility to do M&A. We are still going to be very disciplined about it and make sure that we do deals that make sense strategically from a long-term perspective. But yes, you could see a pickup. Like I said, there are a lot of deals out there. We're looking at some. We'll see how they shake out. But we're not going to go crazy. We're going to be disciplined about what we're doing, but it's nice to have that flexibility again. -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [13] -------------------------------------------------------------------------------- And as far as -- sorry, as far as the greenfield, we're looking at 2 to 3 greenfields for next year that we think will come online. In addition, we'll do, of course, our continued investments in expanding and enhancing the capacity of existing facilities. -------------------------------------------------------------------------------- Operator [14] -------------------------------------------------------------------------------- Our next question will come from Matthew Bouley, Barclays. -------------------------------------------------------------------------------- Matthew Adrien Bouley, Barclays Bank PLC, Research Division - VP [15] -------------------------------------------------------------------------------- Congrats again on the quarter. I wanted to ask a bit about the pricing tools. Obviously, lumber prices, perhaps creeping back a bit, I guess, around the better single family market. So can you kind of discuss what you've seen over the past few weeks with lumber bottoming and moving higher a bit if that kind of provides a bit of a test? If you guys can kind of point to any tangible improvements you've seen as a result of your pricing initiatives, perhaps relative to past years reflecting these efforts? -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [16] -------------------------------------------------------------------------------- Yes, lumber has moved a little bit. It hasn't moved significantly. Most of the pricing initiatives we've done to date are really focused more outside of the lumber products. And really, what we're doing there is just creating a lot more structure on a market level basis and more of a market level pricing concept, and making it easier on our operators at the local level to do pricing more accurately and quicker and just taking some of the manual process out of it. So no, I wouldn't say the little bump we've seen in lumber has been, as you described, a test on our initiatives because most of those are focused on the categories outside of lumber to date. -------------------------------------------------------------------------------- Matthew Adrien Bouley, Barclays Bank PLC, Research Division - VP [17] -------------------------------------------------------------------------------- Okay. Got it. And then I just wanted to ask about the Q4 guide. I was just looking at the revenues. I guess, number one, is there -- I didn't hear if there's anything we need to be aware of around selling days there. And then just looking at the implied volume numbers relative to the third quarter, if I'm doing the math right, it would seem you're guiding to a bit of a deceleration, and correct me if I'm wrong there. Did you see anything in October that's driving that? Or are you guys just kind of layering in some conservatism? Any detail there? -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [18] -------------------------------------------------------------------------------- Yes. So that -- I mean, the fourth quarter forecast is always tricky, given the weather patterns, the normal seasonality. That's -- it's a challenging quarter as the team is really focused on preparing themselves for the lean months and preparing for the upcoming year. Well, we will have 1 less selling day in the quarter, so that's a factor as well. But we certainly feel good about the performance coming out of the fourth quarter. We -- we're certainly not pessimistic at this stage. We are seeing the expected increases as the customers are seeing healthy orders coming in. So we feel good about that and feel pretty optimistic about how things are shaping up for both fourth quarter, but also for 2020. -------------------------------------------------------------------------------- Operator [19] -------------------------------------------------------------------------------- Our next question will come from Mike Dahl, RBC Capital Markets. -------------------------------------------------------------------------------- Michael Glaser Dahl, RBC Capital Markets, Research Division - MD of U.S. Homebuilders & Building Products [20] -------------------------------------------------------------------------------- I wanted to ask a question about OSB. So OSB prices have started to move higher, and I think the industry has taken off about 10% capacity over the recent weeks. So there's an expectation from some of the analysts covering those stocks that you're going to see a material move higher in OSB pricing. Can you remind us how much or what percentage of that -- of your business would OSB represent, either in the lumber and sheet goods category or also if it's part of manufactured products? And just any color around what you're seeing, hearing and how you think you can manage that? -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [21] -------------------------------------------------------------------------------- Sure. I can baseline it and let Chad maybe talk about his sense of the market. But the commodities, broadly speaking, represents right around 40%, just about the same as the value-add of our total sales. Within that category, OSB is roughly 30%. So overall, maybe 12% of sales. OSB is not a substantial part of the manufacturing components. Obviously, lumber is, but not a substantial part. It only comes into play when we've got wall panels with applied sheeting. -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [22] -------------------------------------------------------------------------------- Yes. And I'll just comment on some of the curtailments that have been announced. Long term, as we've talked about over the years is we prefer higher prices. And so if it does -- if some of these curtailments does lift prices, that's a good thing. As you know, we will see a little bit of margin compression in the interim. But longer term, that's a good thing for us. We view some of the curtailments more as taking some of the incremental capacity that's come online in the last year or 2. So our view is, yes, it will help firm prices, but I think a lot of it is still going to depend on the demand that we see, especially going into the spring building season next year. But in my mind, curtailment is a good thing because we prefer the higher prices. And as far as managing through it, I'm not worried about that. My gosh, look what we managed through back in 2018, and I think we did an outstanding job doing that. So as far as managing through the fluctuations, that doesn't concern me. -------------------------------------------------------------------------------- Michael Glaser Dahl, RBC Capital Markets, Research Division - MD of U.S. Homebuilders & Building Products [23] -------------------------------------------------------------------------------- Okay. That's helpful color. And I guess, maybe just to follow on, if we're thinking out into 2020, and obviously, the results this year have been excellent. Is there a way to ballpark kind of from the 2019 guide, how much of that was -- I don't want to say totally nonrecurring benefits, but effectively, just the benefits of the favorable price costs? And then from a baseline standpoint, it seems like volume growth should be sufficient to offset whatever you lose there. But just any preliminary thoughts on how you're thinking about EBITDA, the EBITDA dollar growth potential next year, given you likely lose some of that tailwind from price cost? -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [24] -------------------------------------------------------------------------------- Yes. So no question. You're absolutely correct that we received some of the benefits from the tailwind as the deflation hit. We were pretty open about that as we went through the year. There'll be some of that next year. We agree growth will be, obviously, a tailwind for us next year. We feel good about both the markets and our competitive position. So I think those are positives. Not ready to give a specific guide on that, but we do anticipate having that for our next call as we roll out our 2020 numbers for the Q4 call. So absolutely intend to break that down for you. -------------------------------------------------------------------------------- Operator [25] -------------------------------------------------------------------------------- Our next question will come from Alex Rygiel, B. Riley FBR. -------------------------------------------------------------------------------- Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [26] -------------------------------------------------------------------------------- Your organic growth in the quarter was very, very strong, particularly with regards to your value-added products. The homebuilders are seeing incredible demand over the last 3 months and in the month of October. Can you talk a little bit about your ability to keep up with their demand in the coming months? Talk a little bit about your ability to add labor, and maybe highlight what your utilization rate of your facilities is right now? -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [27] -------------------------------------------------------------------------------- Keeping up with demand. I mean labor is a challenge. It has been for years, especially in areas. Drivers has gotten a little better, but still yard personnel and folks working in our manufacturing facilities. Labor's tough, but I'm confident that our facilities can handle the demand, whatever the builders throw at us. We could struggle at times with employees, but we've got a lot of temp agencies that we use, and we call on them when we need to. So from our standpoint, bring on the demand because we've got the footprint to handle it. I'm not too worried about our capacity. -------------------------------------------------------------------------------- Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [28] -------------------------------------------------------------------------------- That's great. And as you reengage in M&A, can you comment on seller price expectations these days? And what kind of competition you're seeing out there? -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [29] -------------------------------------------------------------------------------- Some of the deals we look at are auctions. Some of them aren't. Some of them come from relationships that we've kind of been cultivating over the years. Those are our preferred, right, so you're not in the bidding process. But overall, I would say, sellers' expectations are pretty much in line with what buyers want to pay these days. The last -- I would say, over the last couple of years, they seem to have come down a little bit, the seller's expectations. So it's, in my opinion, a pretty good time to be a buyer out there. -------------------------------------------------------------------------------- Operator [30] -------------------------------------------------------------------------------- Our next question will come from Keith Hughes, SunTrust. -------------------------------------------------------------------------------- Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [31] -------------------------------------------------------------------------------- Some of the commentary on the call here on the good order book, I mean, the builders, a fair amount of that's coming towards the low end of the market. I would assume that would be a positive for you on -- given your push into truss manufacturing, I would love to kind of hear your opinion on that. And any other impacts that would have, either positive or negative, on your business? -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [32] -------------------------------------------------------------------------------- Well, you're right. A lot of the incremental demand we're seeing is in some smaller homes and really to meet some of the affordability issues that's been facing homebuyers. In my opinion is always, the more houses we build, the better. We're a distribution company to a large degree, and we need volume. And my belief is if we're ever going to get back to that normal $1 million to $1.1 million in single-family houses, you've got to have a higher contribution from the lower-end homes. So to me, it's just all about let's build homes. And to you comment on it playing to our advantage. Yes, we obviously have a very large manufacturing footprint. And when you're building some of these column starter homes, a lot of the -- especially the national builders, we'll use repeat home designs. And so we can be very efficient in our truss plants when we're building those houses. There's just not as many changes to the truss line setup. So yes, there are some incremental efficiencies for us there. But clearly, as homes get smaller, you're losing other parts of the home. You may have a few more or few less windows, a few less doors. But again, net-net, it's all about building more homes for us. -------------------------------------------------------------------------------- Operator [33] -------------------------------------------------------------------------------- Our next question will come from Trey Morrish, Evercore. -------------------------------------------------------------------------------- James A. Morrish, Evercore ISI Institutional Equities, Research Division - Analyst [34] -------------------------------------------------------------------------------- I just want to add my -- great job on the quarter. So I wanted to talk about the value-added products a little bit. You highlighted how they're definitely a tailwind, and definitely, they're something that seems like builders are looking to more and more. But could you just talk about how you think builders are going to continue to shift more towards the use of those value-added products over time, given labor constraints and given your abilities to continue to make more as you either acquire or build out greenfield locations for those? -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [35] -------------------------------------------------------------------------------- Yes. Well, I look at it -- it's a cyclical business, right? And there's times when labor's tight, and there's times when housing slows and labor is readily available. This has been the longest streak I can ever remember of tight labor, and there's many reasons for that. But I just don't see it solving itself anytime soon. And I think as the years tick by, the builders are starting to see that as well. And so a big driver for them is the labor shortage, the cost of framing labor. And they're looking for ways to mitigate that and improve their cycle times, especially the national builders. They're under earnings pressure, just like every other public company out there. And so they're continually looking for ways to build houses quicker and more efficiently. And in my opinion, that's what's driven a lot of them to the product. And then history has also proven that as they switch to these products, very seldom will they switch away from it because they realize the benefits in the cycle time and the cost savings. So it's just, overall, an environment that's pushing more and more builders in that direction. -------------------------------------------------------------------------------- James A. Morrish, Evercore ISI Institutional Equities, Research Division - Analyst [36] -------------------------------------------------------------------------------- And do you see anything that would accelerate that move to more value-added products? Or do you think it's going to be more of a gradual shift in that direction? -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [37] -------------------------------------------------------------------------------- Well, typically, it's been a slow-to-change industry. So my gut would say it's going to be gradual. Now if we see a really big surge in housing demand, for example, next year, that could push more and more builders to that because obviously, labor -- framing labor would become even more scarce. But in general, I would say, gradual barring some unexpected increase in demand. -------------------------------------------------------------------------------- James A. Morrish, Evercore ISI Institutional Equities, Research Division - Analyst [38] -------------------------------------------------------------------------------- And then just thinking about your volume growth that you've done this year. Clearly, very well in a challenging housing environment, to say the least. But just thinking out to next year, is there a reason to think why in a better housing market, your volume improvement should be lower than what you've done so far this year? -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [39] -------------------------------------------------------------------------------- Now, everything else being equal, I don't -- I wouldn't anticipate it changing significantly. I'm a pretty conservative guy, so I -- our volume gains have been pretty damn impressive this year. So I'm always a little hesitant to say we're going to keep doing that. But generally speaking, now, if everything else stays the same and demand is better than expected next year, I -- yes, I think it's certainly possible that we can hang on to those volume gains. -------------------------------------------------------------------------------- Operator [40] -------------------------------------------------------------------------------- Our next question will come from Megan McGrath, Buckingham Research. -------------------------------------------------------------------------------- Megan Talbott McGrath, The Buckingham Research Group Incorporated - Director [41] -------------------------------------------------------------------------------- I wanted to follow up on that conversation around lumber prices. In the sense of -- if we think about a time when that commodity deflation reverses or at least stabilizes and we get some top line revenue growth, how do we think about 2 things: your ability to sort of get or for us to see more clearly SG&A leverage from your operational initiatives, as well as you mentioned cash flow benefiting from the lower lumber prices. So how do you feel about your ability to kind of continue to generate strong cash flow, if and when that lumber reverses? -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [42] -------------------------------------------------------------------------------- Yes. So the thinking around SG&A, we certainly do expect to get SG&A leverage as the sales increase, and you saw us delever this year. We generally think about our SG&A as being 70% variable. So there's some leverage associated with that. We do have internal initiatives that relate to the operational excellence initiatives, we will call those out to give you a chance to get a clearer understanding about what we're up to. But certainly, we'll see that in there. As far as the overall growth of the business, we certainly think that the increases in lumber and commodities, given where prices are, are more likely to decreases from here. We think that our ability to grow the business and to leverage off of those is consistent. I mean, obviously, we've gotten through an up and a down cycle in commodities. So we feel like -- we've, as Chad mentioned, feel really very good about our ability to manage through it and to be able to leverage that kind of both directions. I'm not sure if I hit both of your questions. -------------------------------------------------------------------------------- Megan Talbott McGrath, The Buckingham Research Group Incorporated - Director [43] -------------------------------------------------------------------------------- Any thoughts on cash flow? -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [44] -------------------------------------------------------------------------------- Yes. I mean, I think the cash flow side of it is... -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [45] -------------------------------------------------------------------------------- Is -- there's no question that as the values of commodities increase for both in -- well, for the value of both lumber and OSB, we will see correlating increases in the values of AR inventory and AP, on our side. So no question, there's a fair share of the benefit, both at the end of last year and through the first half of this year from, a cash flow perspective has been because of that deflation. We'll absolutely be investing cash as we go the other direction. That said, there is a component of this that really is attributable to, I would say, enhanced focus and discipline, enhanced processes and procedures internally. So we feel good about holding on to that. But yes, I'd be crazy to tell you, it wasn't going to cost us some money if things reinflate. -------------------------------------------------------------------------------- Megan Talbott McGrath, The Buckingham Research Group Incorporated - Director [46] -------------------------------------------------------------------------------- Right. Okay. And then just a quick follow-up on the repair/remodel and multifamily segments. You pointed to some improvements in, I think, Southern California for repair model. And it sounded like maybe some pent-up demand in multifamily running through. So any more color on that, and whether that was sort of onetime in the quarter. Or if you think it will last another quarter or 2, that would be helpful. -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [47] -------------------------------------------------------------------------------- Yes, that's a great question. I think that when it comes to the R&R component, of R&R and Other, we've seen some stabilizing. We've seen some -- while still down more stable on a year-over-year comp basis in the Midwest, for example, we've seen some stabilization and even some modest improvement in Alaska and some improvement in Southern California. The area that's probably the more volatile component is the Other. So we do a fair amount of commercial and industrial. As you called out, we have a multifamily business that's doing well. But that Other is a lot of project-driven business. It's been very good to us this quarter. There's some parts of the country that have competed very well, taking advantage of stumbled competitors, so I think we feel good about that. For the quarter, it's a -- it's obviously a win. I don't think I'd want to extrapolate that forward, but we do feel good about at least lapping the negatives from the prior year in terms of the impact of tariffs and really the hard turn in that Southern California market. -------------------------------------------------------------------------------- Operator [48] -------------------------------------------------------------------------------- Our next question will come from Matt McCall, Seaport Global Securities. -------------------------------------------------------------------------------- Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [49] -------------------------------------------------------------------------------- So the -- I just want to better understand a couple of things. So if I try to look at volume by product category, I think you said value-add overall was up 11%. I know there's -- I think there's 17 points of commodity pressure. But if I just look at the -- I'm trying to better understand the impact on manufactured products, products from the commodity moves. And I guess, I'll tell you the way I thought about it is, did you see revenue pressure but maybe there's a profitability benefit from a lower input cost. Am I thinking about the directional nature of those 2 items the right way? -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [50] -------------------------------------------------------------------------------- I'm not entirely sure I understood. I think what I can say is that we did see growth, both in volume and in margins. Certainly, the unadjusted growth for manufactured components is less because of the substantial headwind that we've seen from commodities. But manufactured products grew solidly in the double digits. Some of the other value-add grew, I would say, high singles to get that average of about 11% in the total value-add component. Does that help? -------------------------------------------------------------------------------- Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [51] -------------------------------------------------------------------------------- It helps. It helps. I'm just trying to make sure I think about -- I don't know what percent of that $360 million impacted your lumber and lumber sheet goods versus manufactured products. Or maybe I should, but I don't. Have you ever broken that out? Or is it easily -- easy to calculate? -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [52] -------------------------------------------------------------------------------- I don't think we have. -------------------------------------------------------------------------------- Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [53] -------------------------------------------------------------------------------- Okay. All right. Well, no, you don't -- that's fine. Yes. So the next question, I want to go back to the technology. And I definitely understand the benefits that you discussed, but can you put any numbers to that? I know that -- is there a way to look at market share gain, margin impact? You talked about cash collection and some of the improvements there. Can you put any numbers to that? And maybe quantify any benefit that you're seeing? And what would be some of the expected benefits from a numbers perspective as we move out to 2020? -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [54] -------------------------------------------------------------------------------- Yes. So I mean, a couple of factors. I guess, if you look at our total working capital metrics, we've got some pretty substantial improvements. There are 2 components to that, obviously, in different -- the 2 different drivers, operational versus deflation. Where you will see the benefit is in reduced inventory. You'll see it in -- so lower DIO or days inventory on hand. Lower DSO and days sales on hand in the AR metric. You'd see it in a lower SG&A as a percent of sales as we go through the aspect of the efficiency generated by utilizing online tools, having automated interfaces that allow us to be more efficient from the administrative side. And there's an efficiency also associated with -- any time you're applying cash and trying to work with a customer, you're utilizing labor resources to do that. The customer is doing it themselves. Obviously, it's always right because they're doing it themselves. So we haven't called out a dollar amount. We're planning to roll that into the operational excellence update. As we get into the full year, we'll update the full year, but we'll definitely call that out. Now I think it's fair to say that we're not looking at doing this as a labor cut basis for restructuring like some companies do. I think what we're really focused on is filling in for attrition and really looking at how do we continue to grow the business and leveraging the resources we already have on hand. Because it's hard to get good people, and we want to make sure we take advantage of the ones we have on staff. -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [55] -------------------------------------------------------------------------------- Yes. And I'll just add real quick. Some of the operational excellence initiatives are easier to measure than others, like customer engagement on our website, kind of hard to pin down a dollar benefit to that. But some of them are a little easier. The margin expansion and the logistics initiatives, those are much more tangible and easier to measure. We've guided to $14 million to $16 million of benefit in 2019. I think we have a chance to do a little better than that. But if it helps, that's a pretty even split between margin and SG&A right now, those savings. And the SG&A portion really is -- shows itself as a more efficient yard labor and more efficient running of our trucks and less fuel cost. But if that helps, that's a pretty even split between margin and SG&A on those 2 items. -------------------------------------------------------------------------------- Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [56] -------------------------------------------------------------------------------- And then you'll give an update on the 2020 expectations next call? -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [57] -------------------------------------------------------------------------------- Yes. -------------------------------------------------------------------------------- Operator [58] -------------------------------------------------------------------------------- Our next question will come from John Baugh, Stifel. -------------------------------------------------------------------------------- John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [59] -------------------------------------------------------------------------------- My congratulations as well, great execution. Could you remind us of your long-term goal on the percentage value add, number one? And does the timing to get there change with some of these acquisitions adding to the greenfield strategy? And does that long-term goal maybe rise a little bit from your original thinking, seeing what's your -- the labor shortage and the success. And seemingly, the demand pull you're getting from your customers? -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [60] -------------------------------------------------------------------------------- Yes. Well, from my standpoint, the higher our value-add mix is, the better. And clearly, the acquisitions we're making could help get us there sooner -- should help get us there sooner. I guess, our kind of our nearer term goal is more of a 50-50 mix between lumber and our distributed product and value-added product. But I certainly would not be -- wouldn't be heartbroken if we hit that number and continue to blow past it. It's clearly the most profitable part of our business. I think it helps differentiate our company versus some of our peers. And so yes, the near term is 50. But longer term if we can get past that, I'll certainly shoot for it. -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [61] -------------------------------------------------------------------------------- I think it's worth pointing out that this quarter, our value-add business is a greater percentage of our total sales than our commodities. -------------------------------------------------------------------------------- John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [62] -------------------------------------------------------------------------------- Got it. Got it. And then maybe on a high level, how should we think -- maybe a reflection several years post ProBuild, it seems, from my seat, it wasn't successful. I know it's a lot of work. How do we think about where we are in the housing cycle, where your balance sheet is? And what your appetite may or may not be to entertain another big deal in the next several years? -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [63] -------------------------------------------------------------------------------- Always open to entertaining a larger deal. Maybe something could happen if it was a combination of debt and equity, depending on the size of the deal, maybe an all-cash deal. We never try to be close minded. We're certainly open to opportunities that make sense and are strategic from a long-term perspective. But right now, I don't see any of those on the near-term horizon. Most of the deals we're seeing now are smaller to mid-sized deals but could fit in nicely from a strategic standpoint as well. -------------------------------------------------------------------------------- Operator [64] -------------------------------------------------------------------------------- Our last question will come from Kurt Yinger, D.A. Davidson. -------------------------------------------------------------------------------- Kurt Willem Yinger, D.A. Davidson & Co., Research Division - Research Associate [65] -------------------------------------------------------------------------------- Appreciate all the details. I just wanted to go back to volumes and maybe take it in a bit of a different direction. Obviously, really positive trends on the value-add side. But the other categories have grown pretty well, too. And so I'm wondering whether you think you can be a share taker going forward in those non-value add categories? And if so, what do you think is really separating kind of Builders FirstSource versus your competitors? -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [66] -------------------------------------------------------------------------------- Yes, we can be a share taker in other categories. But to me, it's -- a lot of it boils down to pricing and margin expectations and return on investment. We've always said over the years, you can take all the share you want if you're prepared to drop your drawers and lower your prices. But we tend not to do that. We try to be very, very thoughtful about how we allocate our capital and return on investment. So yes, if the returns are adequate, we're more than happy to grow share there as well. But the -- I'll call it the distributed side of our business, it's the most competitive. And so clearly, that results in lower margins on average. So most of our focus over the years has been on the value-add side of the business. Better margins, better ROIC, and that's where we will continue to focus our efforts. -------------------------------------------------------------------------------- Peter M. Jackson, Builders FirstSource, Inc. - Senior VP & CFO [67] -------------------------------------------------------------------------------- There's no question that the portfolio that we're able to offer, based on our scale and our product breadth, has been mutually beneficial. I mean, as we do a really good job with our customers, and we partner with them on value add, really makes a lot of sense, just ease of doing business to work with us on the other products that they purchase as well. And as long as it's a fair price, it's been a fun way for us to continue to grow the business. -------------------------------------------------------------------------------- Operator [68] -------------------------------------------------------------------------------- At this time, there appear to be no further questions. So, Mr. Crow, I will turn the call back over to you for any closing remarks. -------------------------------------------------------------------------------- M. Chad Crow, Builders FirstSource, Inc. - CEO, President & Director [69] -------------------------------------------------------------------------------- Yes. Thank you again for joining our call today, and we look forward to updating you on our fourth quarter and our full year results in February. And if you have any follow-up questions in the meantime, please don't hesitate to reach out to Binit or Peter. Thank you. -------------------------------------------------------------------------------- Operator [70] -------------------------------------------------------------------------------- Thank you very much. Ladies and gentlemen, at this time, this now concludes our conference. You may disconnect your phone lines, and have a great rest of the week.