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Edited Transcript of BMCH earnings conference call or presentation 28-Feb-19 1:30pm GMT

Q4 2018 BMC Stock Holdings Inc Earnings Call

RALEIGH Apr 12, 2019 (Thomson StreetEvents) -- Edited Transcript of BMC Stock Holdings Inc earnings conference call or presentation Thursday, February 28, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Carey Phelps

BMC Stock Holdings, Inc. - Director of IR

* David E. Flitman

BMC Stock Holdings, Inc. - CEO, President & Director

* James F. Major

BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer

* Michael P. McGaugh

BMC Stock Holdings, Inc. - Former Executive VP & COO

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Conference Call Participants

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* Brian Biros

Thompson Research Group, LLC - Equity Analyst

* David John Manthey

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* James A. Morrish

Evercore ISI Institutional Equities, Research Division - Analyst

* James C McCanless

Wedbush Securities Inc., Research Division - SVP of Equity Research

* Keith Brian Hughes

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Kurt Willem Yinger

D.A. Davidson & Co., Research Division - Research Associate

* Marshall Harrison Mentz

Barclays Bank PLC, Research Division - Research Analyst

* Matthew Schon McCall

Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst

* Michael Glaser Dahl

RBC Capital Markets, LLC, Research Division - Analyst

* Susan Marie Maklari

Crédit Suisse AG, Research Division - Research Analyst

* Trey Grooms

Stephens Inc., Research Division - MD

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Presentation

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Operator [1]

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Good morning and thank you for standing by. You are joining BMC's Fourth Quarter 2018 Earnings Conference Call. This call is being recorded today, Thursday, February 28, 2019. Carey Phelps, Director of Investor Relations for BMC, will now provide the company's opening remarks.

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Carey Phelps, BMC Stock Holdings, Inc. - Director of IR [2]

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Thank you. Good morning and welcome. After my opening statement, Dave Flitman, our Chief Executive Officer; Mike McGaugh, our Chief Operating Officer; and Jim Major, our Chief Financial Officer will discuss our key priorities and our operating results for the fourth quarter of 2018. In addition to our prepared remarks, a slide deck is available on our website at ir.buildwithbmc.com. This is also where you can find today's press release, which was issued earlier this morning.

The results discussed in this call will include GAAP and non-GAAP results adjusted for certain items. We provide these non-GAAP results for informational purposes and they should not be considered in isolation from the most directly comparable GAAP measures. The reconciliation of these non-GAAP measures to the corresponding GAAP measures and a discussion of why we believe they are useful to investors can be found at the back of the press release and in the slide presentation.

Our remarks in the press release and on this call contain forward-looking and cautionary statements within the meaning of the Private Securities Litigation Reform Act and projections of future results. Please review the forward-looking statement section in today's press release and in our SEC filing for various factors that could cause our actual results to differ in a material way from forward-looking statements and projections.

With that, I'll turn the call over to Dave.

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [3]

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Thanks, Carey. Good morning, everyone, and thanks for joining us. I am pleased to share with you today the strong result our team delivered for 2018. Specifically, we grew our total sales by 9.4% to $3.7 billion, driven in part by strong growth in structural components of 19%; increased sales of Ready-Frame by $62.3 million, up 36.4%, to $233.5 million; more than doubled our annual net income; grew adjusted EBITDA by 33%, and expanded adjusted EBITDA margin by 130 basis points to 7.2%. As a result of these successes, we more than doubled cash provided by operating activities to $210 million, up from $94 million a year ago.

I commend the entire BMC team on a job very well done in 2018, a year in which we delivered record result. Hoping to drive our success in 2018 was the progress that we made advancing our strategic pillars, which as a reminder are; one, organically grow our value-added product offerings; two, drive efficiencies and enable outstanding customer service through the BMC Operating System in our operational excellence initiatives; three, build a high performance culture; and four, pursue the right acquisitions to expand our geography, increase our capacity and/or enhance our value-added offering.

I'm going to hand the call off to Mike for a couple of minutes to highlight the progress we've made on the first 3 of these pillars and then I'll briefly discuss pillar #4 before Jim discusses our fourth quarter results in detail.

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Michael P. McGaugh, BMC Stock Holdings, Inc. - Former Executive VP & COO [4]

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Thanks, Dave. What a great year for BMC. In addition to the clear financial success we achieved during 2018, we took key steps forward in each pillar of our strategy. Starting with pillar 1, our goal of organically growing our value-added product offering. During 2018, we more closely aligned our field compensation practices with our focus on value-added category growth. In addition, we made key investments throughout the year to probably strength our value-added capabilities and structural components, millwork and doors.

As we highlighted last fall, our first-of-its-kind automated truss facility in Cumming, Georgia has been a tremendous success. We not only added capacity in a market that needed it, but we also delivered 40% more board foot per man-hour in our traditional truss line did on average for the fourth quarter. Because of its success, we're quickly moving to expand the use of this technology. Previously, we announced automated truss line investments in Austin and Salt Lake City. These lines are progressing well and we expect to start up Austin in the second quarter and Salt Lake City in the third quarter.

Innovation, our value-added production activities, is not limited to just truss manufacturing. Where it makes sense, we're upgrading other pieces of equipment to increase our production level and reduced cost. Whether it's a saw in Denver that can precision cut entire bunks of wood to stud links in only minutes compared to nearly half an hour when done the old way or a state-of-the-art door machine in Dallas that nearly doubles our door production as compared to the machine it replaced, we're identifying opportunities making capital investments to improve speed, efficiency and reliability in our processes. With increased flexibility and lead times and better service levels, our customers win making us the more attractive partner for builders and contractors.

Hand-in-hand with these efforts is the second pillar of our strategy, using the BMC Operating System in our operational excellence initiatives to deliver improved customer service and drive higher margins across the company. During 2018, we significantly improved our customer service levels as indicated by our higher On-Time and In-Full or OTIF results. By improving this metric, we provided our customers additional value enabling them to reduce cycle time and increase their efficiency, while reducing their total cost.

In addition, our rigorous and analytical approach to both pricing and purchasing certainly benefited our margins in 2018, as we saw commodity cost quickly rise in the first half of the year. Now as we face commodity cost deflation, continuing this intense focus on pricing and purchasing excellence will be key to our success. One of the key deliverables of the BMC Operating System is to drive a larger wedge between pricing cost and improved margin performance. On the price side, we aim to deliver exemplary service, which provides value to our customers. On the cost side, we create value for our suppliers by aiming to be a low cost to serve partner.

In addition to price and cost, the BMC Operating System also focuses on the elimination of waste using the elements of 5S; sort, straighten, shine, standardize and sustain, plus our newly added sixth S for safety. During 2018, we completed over 100 lean events throughout the company, with each delivering either savings and/or productivity improvement. 6S and 7 Wastes have now been rolled out into 80% of our markets with full introduction expected later this year.

Our relentless efforts on operational excellence -- the operational excellence pillar feed right into the goals for our third strategic pillar, building a high-performing culture focused on execution. To this end, we've increased training opportunities in both the sales and management level, and we brought a number of new associates on board hiring 42 trainees during 2018. We're continuing to make investments in our leadership development, culture, engagement and succession planning. The BMC Operating System in our commitment to achieving continuous improvement has changed how we operate the company. It's part of our culture and it's here to stay.

I provided an overview of the progress was made on our first 3 pillars. Let me turn the call back over to Dave to cover our fourth pillar, which relates to strategic acquisitions. Dave?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [5]

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Thanks, Mike. Subsequent to year-end, we were pleased to announce 2 acquisitions in the Charlotte market. The additions of the highly respected Barefoot & Company and Locust Lumber make us one of the top players in the building products based in Charlotte and provide us with additional value-added capabilities in that important market. These acquisitions were both the result of our proactive efforts to build relationships with our internally identified key targets. Completing acquisitions that enhance our value-added capabilities and/or enhance our footprint are high on our priority list.

Our head of business development, Drew Whitcomb, started with the company in January 2018 and has done a terrific job identifying a solid pipeline of opportunities and formalizing our outreach efforts. He deserves a lot of credit for working with our local management team to help cultivate the recent deals in Charlotte. And since his arrival, we've identified well over 300 potential tuck-in targets in the $25 million to $250 million revenue range. We believe our pipeline is solid and we look forward to announcing a more consistent chains of deals going forward while still maintaining a disciplined approach to our investment analysis and transaction pricing. I believe BMC has the right strategy and we are continuing to build strength and momentum in executing each of our strategic pillars.

Before passing the call to Jim for a detailed look at our fourth quarter results, I'd like to recognize one of our team mates who has demonstrated tremendous long-term commitment to the company as he celebrated a remarkable milestone. In January, [Lynn Connelly], a retail sales manager in our Cedar Park lumberyard in Austin, Texas celebrated, his 50th anniversary with BMC. Lynn has obviously seen considerable change over the years in the housing industry as well as inside BMC, but he's remained a steady force helping us to drive the company's success.

Lynn, I appreciated the opportunity to meet you last week on my tour of Central Texas and I want to thank you for your contributions to BMC through the years. We're thankful to have you on our team and we look forward to celebrating your future work anniversaries with you.

With that, I'll turn the call over to Jim for a detailed look at our fourth quarter results.

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [6]

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Thanks, Dave. We ended the year with another quarter of very solid results. Net sales in the fourth quarter increased 2.2% to $859.5 million. We estimate that our net sales increased 1.6% as a result of an extra selling day during the quarter as compared to the prior year, 1.9% from the acquisition of Shone Lumber, and 0.6% from other organic growth, partially offset by a 1% decline due to commodity price deflation and a 0.9% decline as a result of the disposal of our non-core Coleman Floor business on November 1.

Sales of our Structural Components category led our sales growth for the quarter with an increase of 17.4%. This is an area where we continue to be encouraged by the strong growth and enthusiasm in our markets, as more builders realize the value we can provide with our time and labor saving offerings such as roof trusses, floor trusses, wall panels, and engineered wood products.

We are increasingly recognized and sought out by builders as a leader in innovation within our space. Ready-Frame continues to gain traction and grew nicely in the fourth quarter to $58.2 million in sales, up nearly 30% for a year ago. We estimate that Ready-Frame volume growth in 2018 was approximately 21% and we believe we can continue to grow Ready-Frame volumes at a double digit rate in 2019 even if overall growth in housing starts is somewhat muted.

Gross profit increased 16.9% to $229.2 million for the fourth quarter as a result of a rapid decline in commodity cost, which began during the summer of 2018 and bottomed out in the last 2 months of the year. We recorded an extraordinary 340 basis point improvement in overall gross margins from 23.3% a year ago to 26.7% this quarter. As we noted in our press release this morning, this result reflects a 630 basis point year-over-year improvement in gross margin within the lumber and lumber sheet goods category, and a 550 basis point improvement within structural components.

Selling, general and administrative expenses during the fourth quarter rose to $174 million compared with $154.7 million a year ago. $8 million of this increase related to variable compensation such as sales person commissions, stock-based compensation and profit-based incentives resulting from our strong performance this year. $3.9 million of the increase related to other increases in employee compensation benefits and other employee related costs, and $3.5 million of the increase related to SG&A at the recently acquired Shone Lumber business, $2 million related to a gain on the sale of property in the prior year and $0.5 million related to increased diesel fuel costs.

For the quarter, SG&A as a percentage of sales was 20.2% compared to 18.4% a year ago, but this was primarily the result of the increase in variable compensation, the prior year asset gain, and the decline in commodity selling prices, which reduces the total sales dollars we can leverage against our fixed costs. Our strong performance drove net income higher by $10.5 million to $28.1 million for the quarter or $0.41 per diluted share as compared to $0.26 per diluted share in the same period last year.

Adjusted net income for the fourth quarter increased $17 million to $32.3 million or $0.48 per diluted share, which is more than double the $0.23 per diluted share we realized in the prior year. Adjusted EBITDA improved $17.9 million compared to the prior year quarter to $65.5 million as organic growth, increased gross margins, acquisitions and other operational improvements produced $23.5 million of net incremental benefits. These were partially offset by a $1.6 million reduction to adjusted EBITDA from commodity deflation, a $2 million decline from our disposed Coleman Floor business, and a $2 million reduction from the prior year asset gain on the sale of excess real estate.

Another highlight within our 2018 results was operating cash flow, which more than doubled to $99.4 million in the fourth quarter and $210 million for the full year. As a result of this significant improvement, we ended the year with $150.7 million of cash on hand and $460.2 million in total liquidity, which also includes excess availability on our revolver.

As of year-end, net debt declined to 0.7x our 2018 adjusted EBITDA, which we believe places our balance sheet among the strongest and much flexible in the industry. We're proud to note that BMC does not have a single dollar of long-term debt due within the next 5 years. Dave will talk in more detail about our longer-term capital allocation strategy, but one new element is a $75 million share repurchase authorization that we announced in November. Since inception, we have repurchased a total of 0.9 million shares at an average price of $16.63 per share including 200,000 shares that were repurchased at an average price of $15.91 in the fourth quarter of 2018.

Turning our attention to 2019 and so far so good. Despite the pause homebuyers took in late 2018, builders generally entered 2019 with healthy construction backlogs. During the fourth quarter, we saw wetter than usual weather in Texas and our Southeast and mid-Atlantic regions, which resulted in some pent-up demand heading into the first few weeks of 2019. Conversely, we have seen our fair share of winter weather and precipitation in our western markets so far in 2019. Since we enjoyed a very mild winter out west in the early months of 2018, this resulted in a more challenging comparisons in those regions, but we believe the pipeline remains solid once we enjoy better weather.

Just as many of our public company peers have done, we are going to hold off from providing a full year 2019 sales and profitability outlook until there is more clarity around buyer behavior during the crucial spring months. However, with respect to the first quarter of 2019, we are far enough into the period to provide our outlook based on the trends we have seen to date. Despite the regional variations I noted a moment ago, overall construction backlogs have remained stable and we expect 1.5% to 2% of sales growth from recent acquisitions net of the impact from our Coleman Floor disposition. We expect our total first quarter sales to be negatively impacted by 5% to 7% as the Random Lengths lumber index has averaged $350 so far in 2019 after averaging $484 in the first quarter of 2018.

The first quarter of 2019 will also feature one less selling day than the prior year, which is expected to negatively impact first quarter revenue by 1.7%, although we will recover that day in the third quarter. Putting all these pieces together, we expect first quarter net sales to range between $780 million and $820 million. Gross margins in the first quarter of 2019 are expected to decline from the extraordinary result we delivered in the fourth quarter of 2018, but remain above the level we produced in the first quarter of 2018. This year-over-year improvement in gross margins and our continuing focus on expense productivity is expected to yield first quarter adjusted EBITDA between $42 million and $50 million.

While we are unable to provide a full year sales and profitability outlook at this time, we remain confident in our opportunity to realize volume growth in 2019 from the combination of our investments in value-added products, bolt-on acquisitions and the potential for housing starts to reaccelerate over the course of the year.

However, one area that is likely to be a comparative headwind in 2019 is lumber and lumber sheet goods pricing. While commodity pricing is nearly impossible to predict, if lumber indices hypothetically were to continue to average in the range of $350 million to $400 million throughout 2019, and assuming constant sales volumes, we would expect our full year total net sales to be negatively impacted by 4.5% to 8.5% as compared to 2018, with the most difficult year-over-year sales comparisons occurring in the second and third quarters of 2019.

In addition, we would expect gross margins within the lumber and lumber sheet goods and structural components product categories to normalize towards more historical levels during the first half of the year. Beyond that, in the investor materials posted on our IR website, we have provided certain other full year expectations to assist our investors including our CapEx plan.

In 2019, we expect to spend between $80 million and $90 million on capital expenditures to make necessary fleet replacements and invest in automation and other productivity enhancements. This increase is the result of both the exciting opportunities we have to further automate our manufacturing operations as well as the fact that we experienced extended lead times on many of our plan purchases in 2018, which push those cash flows into 2019.

All in all and despite some uncertainty in the market, 2019 is off to a good start and we have strong momentum in driving the financial and operational improvements that are within our control. Our team is highly motivated and we look forward to reporting continued progress in the coming quarters.

So with that, I'll turn the call back over to Dave.

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [7]

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Thanks, Jim. Accelerating our growth strategies including making organic and inorganic investments to enhance our value-added products and services as well as growing our most profitable customer categories remains among our top priorities. And it is the strength of our operating cash flow and balance sheet that underscores our confidence in our ability to make these crucial investment.

Our strong liquidity position of $460 million, along with a low 0.7 leverage ratio at year-end, provides us with significant flexibility to execute against our growth strategy, opening up many avenues to create long-term shareholder value within appropriately aggressive capital allocation strategy. First, as Mike highlighted, we will continue to make investments to drive organic growth in our value-added products and services and are targeting to spend approximately 1.5% to 2.5% of sales annually on CapEx. We believe we are a leader in automation and innovation in the building material space, and we intend to remain so. It sets us apart and will continue to be a primary driver of our success.

Second, bolt-on acquisitions provide an attractive way to augment our value-added capabilities and offerings as well as enhance our geographic footprint. With over 300 opportunities identified including many with very strong reputation and attractive pools of customers, I feel very good about our ability to execute on this aspect of our strategy.

Going forward, we intend to add an average of approximately $100 million to $250 million to our top line annually from bolt-on acquisitions while still keeping the flexibility for larger opportunities should they arrive.

And finally, as Jim noted, our $75 million share repurchase program remains an important element of our capital allocation strategy and provides yet another way to return value to our shareholders. This authorization demonstrates our continued confidence in the strength and long-term growth prospects of our company. Our balance sheet and cash flow provide us the flexibility to opportunistically return capital to our shareholders while continuing to invest in our other organic and inorganic growth priorities.

BMC's performance for 2018 was exceptional as we delivered results our entire team should be proud of. This momentum positions us well as we head into the heart of the 2019 home building season. Despite some market uncertainties, we will remain 100% focused on what we can control. This year, enabled by the BMC Operating System and our solid balance sheet, we will strengthen and capitalize on our key differentiators, including our high level of automation and innovation, our size and scale, our value-added capabilities, and continued improvement in our customer service levels. Our team is energized, and we are all very excited about the opportunity we have to drive long-term shareholder value.

With that, I'll ask Michelle to take us into Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Trey Morrish with Evercore ISI.

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James A. Morrish, Evercore ISI Institutional Equities, Research Division - Analyst [2]

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Great quarter. Very impressed by the gross margin and your ability to keep your sales up. The first thing I want to touch on was the surge in multifamily sales that you guys reported on. I'm wondering what drove such a big 12% year-over-year gain in the quarter. Was there something -- a big project you guys picked up? Was there just generally better improvement in the markets that you are in?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [3]

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This is Dave. I would just comment that multifamily has been a focus of the company for a long time. Over the course of -- particularly in the back half of 2018, we saw a significant improvement in our pipeline that should carry over into 2019, but it's a key focus for the organization, and we're gaining momentum.

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James A. Morrish, Evercore ISI Institutional Equities, Research Division - Analyst [4]

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Okay. Got you. And then just thinking about the gross margin, such a big benefit in the quarter. And so you've been buying as lumber has been coming down, and so you have different prices of lumber in your inventory. So I'm just thinking -- you said how 1Q should still see a bit of a benefit from this massive drop in lumber. But I'm wondering how long do you think a benefit from the fallen number will last. Will it only last through 1Q? Or could some of that sneak into 2Q or maybe even 3Q?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [5]

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Yes. Trey, this is Jim. I think kind of the peak gross margins for us probably occurred in the last couple of months of Q4 and probably carry into the first month or so of Q1. The margins are starting to decline a bit. They're still above historical levels as we sit here today. But as we said on the call, we would expect those to continue to gradually normalize over the coming months and probably run their course here by sometime in the second quarter.

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Operator [6]

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Our next question comes from the line of Matt Bouley with Barclays.

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Marshall Harrison Mentz, Barclays Bank PLC, Research Division - Research Analyst [7]

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This is Marshall on for Matt. Congrats on the results. I wanted to start first on your first quarter sales outlook. Taking into account the moving pieces with lumber prices, your net acquisitions, the selling day difference, it looks like you're only expecting a modest volume decline even at the low end of the range. Could you maybe provide some additional context around what you're seeing in the market or recognizing the comments about weather and some of the backlogs that you saw in 4Q pushed into the first quarter?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [8]

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Yes. I think Marshall that, as Jim made the points in his formal comments here, we did have some weather effects in Q4 that pushed some of the backlog into Q1. But I would just say broadly, while we've seen different effects across various geographies, our backlog and our pipeline is still solid as we entered Q1 and, certainly to Jim's point, what we've seen so far in the quarter.

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Marshall Harrison Mentz, Barclays Bank PLC, Research Division - Research Analyst [9]

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Great. That's helpful. And then a follow-up on the gross margin, specifically in fourth quarter. Obviously, a lot of price discipline. On that, could you talk about the selling dynamics in the quarter? Are you having to walk away from some sales in order to get that margin performance? And just maybe said another way, how do you think your volume in the quarter compared to the overall market?

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Michael P. McGaugh, BMC Stock Holdings, Inc. - Former Executive VP & COO [10]

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This is Mike McGaugh. I'll take that one. We are being more selective with the business we pursue. We are being very disciplined on how we manage price as we've talked about in prior calls. We still see a very healthy backlog, as Dave mentioned, and that allows us to be more selective on which pieces of business we pursue, and you're seeing that in our gross margins.

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [11]

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Yes. And I would just add obviously that the level of price competitiveness or intensity obviously varies depending on the product category. I mean lumber and commodities are always very price driven. And to Mike's point, we continue to be pretty selective in what commodity business we want to take on, and obviously, you can see the positive results of that in our gross margins here both in the fourth quarter and for the full year. Certainly when you move into more of the value-added products, it's much more of a service-driven relationship. And as Mike called out to the operating system where we're working very hard to continue to improve our service levels, and then that helps us to do well and obviously gain the business based on the high level of service that we provide.

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Operator [12]

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Our next question comes from the line of Jay McCanless with Wedbush Securities.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [13]

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The first one I had, before thinking about the Charlotte acquisitions, it looks like you guys are guiding with the EBITDA to roughly 24% gross margin or maybe about an 18% SG&A number. Are those in the ballpark?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [14]

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Are you just talking to Q1 specifically?

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [15]

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Yes. The Q1, sorry. Yes, Q1.

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [16]

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I think that's a little low because, as you heard us, low in both regards in the sense that obviously we expect the gross margin to be higher than Q1 of last year, which was 23.9%. And as we said, we still expect a little bit of lingering benefits from the higher gross margins bleeding in from Q4 to Q1. So you're probably a little low on both counts. SG&A percentage generally higher than most quarters in Q1 just because it's our seasonally lowest quarter historically speaking. And so as a percent of sales, SG&A is usually the highest in Q1 and obviously comes down considerably as you get into the stronger parts of the season.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [17]

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The second question I had, on the multifamily business, if that's going to be a bigger part of your sales going into '19, is there -- or how does the gross margin profile look for that business versus your single-family business?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [18]

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Gross margins in multifamily is fairly close to the company average. We do mix a little more towards millwork and some higher value-added products with our multifamily business. And as such, even though they're larger jobs and larger volumes that we're selling on any particular product or any particular job that we capture, the gross margins still average out to be about normal.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [19]

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And then the last one I had, just staying with multifamily. In terms of customer interest or request for quotes, how is that trending in multifamily now versus last year? And do you guys expect a bigger pickup as we move through the year?

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Michael P. McGaugh, BMC Stock Holdings, Inc. - Former Executive VP & COO [20]

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Yes, this is Mike. The backlog we have for multifamily has improved versus same period last year. We're seeing multifamily get more healthy, and we're optimistic about our involvement with multifamily. We've also made multifamily as well as the value-added products the key focus of our company. We've instituted some best practice councils across the company to drive growth in both multifamily and value add, leveraging best practices across our whole grid. That's something new we've been doing the last year, and you're seeing the results of it.

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [21]

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Yes, there's probably -- there's also a much longer lag, if you will, between multifamily starts and when that turns into revenue relative to a single-family start. Obviously, the projects are much larger and more complex. And so as we saw starts decline -- multifamily starts to decline, some in 2017, that sort of hit us at late '17, early '18. As the starts recovered in 2018, we're now seeing those benefits here in the back half of '18 and heading into '19. So as we said, the backlog remains very good.

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Operator [22]

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Our next question comes from the line of Mike Dahl with RBC Capital Markets.

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Michael Glaser Dahl, RBC Capital Markets, LLC, Research Division - Analyst [23]

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Had a follow-up question first in terms of the overall market thoughts and thinking about your comments in a question earlier. Just to follow up on what you're seeing on the builder side. As clearly the builder order trends have been following "mid- to high single digits" in aggregate, so backlogs are weakening. I guess what I'm trying to understand, part one, is are you saying that this is just kind of a timing difference in terms of when that's going to impact you. Or do you think you're just exposed to different geographies, different builders and kind of a public set? And part two, if I could wrap one into it, is obviously you're also taking shares you've discussed with some of the initiatives around truss and Ready-Frame. So for the sake of argument, if we were saying starts would be kind of flattish for this year, can you help us think about, from a volume standpoint, how much you expect to gain in market share?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [24]

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Sure, Mike. I would just -- this is Dave. I would just say a couple things to that. First of all, a lot of the growth that we're seeing is from the entry-level buyer. And as you've heard a lot in public comments from the builders, they've been spending a lot of time in the fourth quarter and so far this year adjusting their offerings. I think to your point, as footprints of home shrink, it really plays to our strength around structural components and things like trusses and Ready-Frame, as we've spoken about. And obviously, our key objective here is to take market share in those specific areas of our business. On the flip side of that, the smaller footprint hurts millwork. In windows and doors, they tend to have less of all that. So -- but I think on balance, we're not concerned about our ability to grow and take share really in any environment that we see going on right now.

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Michael P. McGaugh, BMC Stock Holdings, Inc. - Former Executive VP & COO [25]

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If I can pile on to Dave's comment. What we're seeing is the overall sentiment of our customer base, which is some of the big publics but also some of the mid-sized custom, it's an improved sentiment versus 90 days ago clearly. And so I think that sentiment gives us confidence going forward.

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Michael Glaser Dahl, RBC Capital Markets, LLC, Research Division - Analyst [26]

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Okay, that's helpful color. My second question is really around thinking through kind of as you've rolled out the first automated truss facility and you're progressing towards the next couple. What I'm curious about is, if you've seen a difference in uptake in terms of what type of customers you're selling to from that versus as you've rolled out Ready-Frame, and so I think -- and correct me if I'm wrong, but Ready-Frame, some of the earlier adopters, I believe were some of the smaller builders. And I'm just curious about whether there is a real difference in kind of customer mix as you're rolling out the trusses versus Ready-Frame?

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Michael P. McGaugh, BMC Stock Holdings, Inc. - Former Executive VP & COO [27]

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That's good question. Now what we're seeing is a more aggressive adoption from some of the larger builders who are getting a bit of pressure on the modular approach. Ready-Frame, trusses and panels are good balance between the stick built and then also the fully -- the full modular approach. And so what we're seeing is -- and we've got a number of pilots underway. We've discussed with some of the larger production builders on finding a way to scale Ready-Frame and trusses. As Dave mentioned, it lines up very well with these entry-level homes and townhomes from a lower cost and lower labor approach. We're seeing strong subscription to our automated facilities. And we talked before about Austin and Salt Lake City, we've got additional cities in the pipeline that we're planning to roll out. That I won't disclose at this time, but that automated capacity on our truss facilities, Ready-Frame panels, and then also even automation of some of our door lines, we think it's going to be a real value adder to our company going forward.

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [28]

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And Mike, one other point of clarification. Obviously, the automation in a truss plant, the truss plant is building the roof system and the floor system whereas Ready-Frame is effectively the wall system. So the 2 work in conjunction. And obviously, the better we did at both, the more of the uptake we can hopefully drive with all of our customers across those different pieces of the house. And when you put those 2 pieces together, that's basically what you're seeing in the overall structural components category, which as we highlighted grew 19% last year and topped over $600 million of revenue in total. So tons of growth there through all these initiatives.

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Operator [29]

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Our next question comes from the line of Susan Maklari with Credit Suisse.

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Susan Marie Maklari, Crédit Suisse AG, Research Division - Research Analyst [30]

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My first question is just around, you talked about the progress you're making with 6S and 7 Waste and some of these other efficiencies. Can you just give us some more color on how we should be thinking about what else you can do there in terms of lean techniques? And as the environment -- the demand environment does shift a little, is it giving you more opportunity or more space to perhaps pull some of these forward a bit?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [31]

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Yes, it's Dave, Susan. I would just say, one of the things that impressed me when I joined the company about 6 months ago was the culture that the organization had been building around productivity. I think great companies drive growth and they feel a lot of that growth and reinvestment in the organization through productivity. And as Mike said, we are continuing to build momentum around that and the culture continues to accelerate. We're about 80% of the way through in terms of rolling out those tools and techniques. I would expect that we're in the early innings of ramping up the impact of that over time. But I feel very good about the momentum here. And as you heard some of the comments, we intend to fuel a lot of our growth from that internal productivity drive.

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Susan Marie Maklari, Crédit Suisse AG, Research Division - Research Analyst [32]

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Okay. And then my next question is, have you seen any maybe early signs of change in the M&A environment? As the demand environment has changed, are you seeing anything where people are perhaps thinking about making a change, getting out of things and could that perhaps accelerate things as we think about 2020?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [33]

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I don't think we've seen any -- this is Dave again. I don't think we've seen any major change in terms of tone in the market. As you heard me say, I feel very good about our pipeline and the work that's been done over the course of the last 12 to 15 months to build our internal capability, to do that outreach, and build relationships with some of these potential targets. As you know, a lot of these are family-owned multi-generational businesses. And it takes relationship building. It takes trust. It takes time to cultivate what could potentially happen there. But I haven't seen any major shift in terms of tone or expectation at this point.

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Operator [34]

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Our next question comes from the line of Trey Grooms with Stephens Inc.

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Trey Grooms, Stephens Inc., Research Division - MD [35]

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So I guess really going to ask about M&A. I think you're definitely ramping that up. And you said I think, Jim, that you could -- or maybe Dave, that you could expect a more consistent cadence of deals. So definitely it sounds like you're committed to doing more acquisitions. But how do we think about or how do you think about leverage targets with this outlook kind of weighing the going after deals with buybacks and timing of acquisitions given where you think we are in the housing cycle at this point?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [36]

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Sure. Thanks, Trey. This is Jim. I'll take that. I mean our overall leverage target hasn't changed any. I think we're comfortable up to 2x, 2.5x leverage. The beautiful thing about the bolt-ons right now is #1, we've got such strong cash flow. We're obviously generating a lot of internal cash that we can reinvest. And as Dave highlighted in the capital allocation priorities, we're going to first and foremost put that back into the business in form of CapEx and all the exciting productivity opportunities that we have within the business. But that still leaves cash left over to continue to be bolt-on. And you never going to time the cycle perfectly in terms of acquisitions which is frankly the other nice thing about just having a more steady stream of bolt-ons as we'll obviously average in over a number of years at different points in the cycle and we think in the long term will create a ton of value about finding the right companies with the right cultures and the right capabilities to join the BMC business. But we think we can do that very prudently, maintain the leverage as of that more than 2x to 2.5x, and frankly with just bolt-ons and some repurchases that still leave just some flexibility to think about the larger opportunity here from time to time, should that come about. So...

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Trey Grooms, Stephens Inc., Research Division - MD [37]

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Okay, that's helpful. And then also kind of sticking with M&A, if you could just maybe talk directionally about what you've been seeing with valuation multiples out there, what's being sought after versus maybe what it has been over the last year or 2? Also any change with the number of potential suitors that may be at the table as you're looking at acquisitions?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [38]

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Yes. I think that's on the multiple side, obviously we've seen public multiples contract over the last year. Private multiples don't react quite as quickly good or bad frankly. Over time, they tend to be fairly static. And so no huge change in that regard, continue to be generally in the mid-single digits. I'm trying to remember the second part of your question, Trey.

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Trey Grooms, Stephens Inc., Research Division - MD [39]

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The second part was just, you guys are definitely being more -- over the last year or so, more active. And what do you see and as far as the other folks at the table, are you seeing the number of potential suitors for these deals increase, decrease, about the same?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [40]

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Yes. I'm not sure of the entire landscape of sellers has changed all that much. But as you note, I think both to our proactive outreach efforts increasing. As well as the fact that again as we continue to move further away from the merger date and all the work that took over the first couple of years, clearly we have more management time to engage with different targets as those opportunities do arise. So that is leading to a stronger pipeline of conversations which ultimately will hopefully lead to a -- we believe will lead to a stronger completion rate of deals.

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Trey Grooms, Stephens Inc., Research Division - MD [41]

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Okay. Last one from me. And I think, Jim, you touched on kind of a range of lumber prices earlier in the comments. But is that kind of $350 to $400 range? You guys are a lot closer to what's going on kind of in the field and seeing what's going on with as far as supply and everything. Is that kind of the -- your outlook is for things to kind of settle down in that range, best we can tell from today? And any input you could give us on just what you're seeing in the market from broad upper pricing?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [42]

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I've been here way too long to try to predict lumber prices. But certainly that's where we are today. We're right around $370, $375 the last couple of weeks. And so we provided that hypothetical just to give people a sense of the order or magnitude at a couple of different points. Obviously, we'd prefer prices to continue to recover some. But that's certainly better for us in the medium and long term, but it is a commodity.

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Operator [43]

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Our next question from the line of David Manthey with Baird.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [44]

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My question is on SG&A. You obviously have the impact of acquisitions coming in your net of divestiture. And as you look at 2019, is there any reason to think that your core SG&A should be significantly higher than 2018?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [45]

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I already said we did a couple of deals early in the year. And so the SG&A base across that $100 million of revenues is somewhere in the $15 million to $20 million range on a full year basis. So that will come in relative to 2018's baseline. And there'll be a few million of savings from the Coleman business going out. The biggest -- I guess the core way we think about SG&A is obviously there is some cost pressure out there right, now particularly around wages. It's a full employment market and so that we are seeing some wage inflation. The flip side is we look to offset the vast majority of that, if not all of it, through our productivity initiatives in the BMC Operating System. And then the only other comment which certainly we called out in the earnings release, but for the fourth quarter and the full year is lot of our associates, whether it's sales people, managers, et cetera, they have a pretty high level of variable compensation. Our sales people are obviously living off the commissions in what they produce in terms of gross profit dollars. Many of our managers and executives and what not have a highest degree based on the overall profitability of the business. So in 2017, it was a far less robust year and those incentives were much lower. In 2018, obviously, as we announced record results, and therefore those incentives and commissions are much higher. All that resets for 2019 with the new plan and new outlook that transpires. And as such, the variable comp could be a little lower in 2019 versus '18.

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Operator [46]

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Our next question comes from the line of Keith Hughes with SunTrust.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [47]

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You've highlighted a pretty aggressive capital-spending program, not higher as a percentage of sales we usually see from distributors. You talked a little bit about the users. But can you kind of prioritize kind of 1, 2, 3, where all that money will be going in the next couple of years?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [48]

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Right. I guess we tried to do that in the investor deck obviously. Our #1 priority is the CapEx.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [49]

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CapEx. I don't have access to that. So I...

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [50]

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No worries, no worries. I mean yes, the 1, 2, 3 is -- #1 CapEx, right, just investing back into the business, and in the end to drive productivity and the organic growth. Without question, that's the highest return that we can deliver for our shareholders here over the near and medium term. #2 is the bolt-on acquisitions because those 2 are certainly great opportunities in the medium and long term to strengthen the business in our overall scale. And then #3 is the repurchases, which we really do opportunistically. Certainly, over the last number of months, we felt like the share price was significantly undervalued and stepped into the market to buy about 900,000 shares. And as long as we -- at different points in the future where we think the share price is undervalued and don't have enough opportunities, and I guess by way of CapEx or bolt-on acquisitions, then repurchases remain something that we'll evaluate from time to time.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [51]

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Okay. Couple of quick ones. The -- particularly with the new acquisitions coming in, what would D&A look like per quarter in 2019?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [52]

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I mean it should be pretty stable by quarter and let me flip to the right page here. In total, depreciation expense -- and this is both what's down below cost of goods as well as in cost of goods, depreciation expense in total we're looking to be $50 million to $55 million. And amortization expense primarily related to our acquisitions is $16 million to $18 million.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [53]

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Okay. And then finally what was the aggregate price paid for the deals that you don't apply here?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [54]

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Between the 2 deals in total, it's just a little bit over $50 million.

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Operator [55]

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Our next question comes from the line of Steven Ramsey with Thompson Research Group.

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Brian Biros, Thompson Research Group, LLC - Equity Analyst [56]

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This is actually Brian Biros on for Steven. I want to ask about the repair and remodel, and it seems like demand fell recently after some strong growth prior to that. And the general feedback we've been hearing is that repair and remodel activity has been better than new construction. So I just want to hear what you guys are seeing on that and kind of reconcile that with the outlook that we've heard from many, of the repair and remodel would show better growth in 2019?

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Michael P. McGaugh, BMC Stock Holdings, Inc. - Former Executive VP & COO [57]

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Brian, this is Mike. You're looking at a fourth quarter to fourth quarter comp, which is a little bit of a difficult headwind. We had a lot of exposure to the Houston market in Pro Remodel and Hurricane Harvey in fourth quarter '17. That was a tough, tough comp on a quarter-over-quarter basis. On a annual-over-annual basis, you can see that the growth is 12% and we believe that's going to continue. Just as I talked about our refreshed approach to multi-family and millwork, we also have a refreshed approach to Pro Remodel. Those are our 3 areas where we're driving growth. We've made some key hires, one of which we've announced recently to run that part of our company. And we've got a very targeted approach on some key markets we're going to -- where we have a competitive advantage. We're going to continue to build out our Pro Remodel presence. I agree with your approach that the Pro Remodel is incrementally more healthy than single family at this point. Our target is to outgrow the market by a reasonable margin and there's every reason to believe we'll do so.

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Brian Biros, Thompson Research Group, LLC - Equity Analyst [58]

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Got it. And one more on the acquisition side, both prior kind of unexpected. Do you expect any kind of material shift in the mix you have due to acquisitions and maybe going after M&A with a more specific end market in mind? Any thoughts on kind of the mix impact from acquisitions would be helpful.

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [59]

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I mean certainly the acquisitions that we are most prone to are those that have the high mix of value-added products and/or a higher mix of remodeling contractors. So certainly, that's been the case. If you look at the last -- the average anyway over the last 5 or 6 deals that we've done, we will on occasion find somebody that's a little bit more of a traditional LBM dealer, which was the case with Locust Lumber. But that was a great opportunity to just add some local scale within the Charlotte market and we think that'll continue to pay dividends and add some customer relationships that we can sell more millwork and trusses and other things too going forward. So over time, certainly we want the mix of our lumber sales to decline as a percent of the total.

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Operator [60]

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Our next question comes from the line of Matt McCall with Seaport Global Securities.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [61]

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So maybe start with the -- I think it was 5% to 7% you talked about is the revenue and earnings bridge, $23 million in incremental EBITDA. Can you kind of break out the operational improvement component to that line? I think, Jim, in a earlier question, you referenced some SG&A savings, but I'm really getting at what the opportunity is as we move out into 2019 from an operational improvement perspective?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [62]

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Yes. I mean obviously the vast majority of what's on the bridge there was the gross margin improvement. And obviously, the great work that our sales team did to hold price and the sourcing team did to minimize our cost on materials. But also embedded in that is some of the productivity benefits we get, whether that's manufacturing labor and our manufacturing plans which benefits cost to sales or a different things we've done around distribution costs and selling costs and things of that nature which help SG&A. So as I think we said earlier, our main goal or overriding goal here for 2019 is to offset as much of the cost inflation that's out there through our productivity initiatives. And obviously, that's many millions of dollars of opportunity as we think about next year.

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Michael P. McGaugh, BMC Stock Holdings, Inc. - Former Executive VP & COO [63]

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If I can build on Jim's point, we talk a lot about in our company about the wedge between price and cost. And our whole objective here is to get our service levels up and that allows us a little more traction on pricing. Get our cost to serve down to our suppliers and that gives us more leverage on our cost. And so we've talked about this now for about a year in the context of the operating system and you guys are now seeing the results. And Dave mentioned, that's really in the early innings of those results. But I want to just continue to stress the work we're doing, the focus we have on pricing excellence in a robust approach on purchasing and then also just the overall productivity improvements, waste elimination that comes with the operating system.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [64]

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Okay, Mike. That actually is a nice segue. And the next question I have -- and, Jim, I think last quarter we talked about a target of 10% to 15% kind of decremental from lumber. If our math is right, looked like it was a little higher than that. What we're trying to figure out is the impact that what Mike just talked about the pricing efforts, the purchasing efforts. How does that change the math around following lumber prices '19 verses '18 versus what we would normally see?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [65]

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Yes. I think it's the normal kind of inherent incremental, decremental around lumber price changes is that 10% to 15%. Clearly as Mike and our teams do the work that he's describing hopefully, we would look to minimize that negative impact in an environment where lumber prices are likely to be down year-over-year. But as you can also tell from our commentary around the first quarter, there's a lot of -- it's a lot of moving pieces in the business right now, whether it's lumber prices or acquisitions or little bit of a disposal or a change in sales days. So we'll put some finer points on that I'm sure in future calls here as we get into the spring and have a little better sense of exactly where volumes and backlogs are heading into the more important months of the year.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [66]

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Okay. And I know we're late, but can I sneak one more in? Mike, you made a comment that you'd seen improved sentiment over the last 90 days. Can you just expand on that? What's driving the improved sentiment? Is there a traffic story there? Is it -- just give me more detail on what you were referencing?

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Michael P. McGaugh, BMC Stock Holdings, Inc. - Former Executive VP & COO [67]

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Yes, sure. So it was a number of industry events, industry conferences where we just take the pulse of the overall community and that's the custom home builders as well as your larger production builders. And if you look back to where we were in October or September, November, I think there was a concern on the interest rate. There was a concern on the outlook for '19. I will say that directionally it's better across the board. We feel that as well and that's reflected in our optimism today on the call. Hopefully, you guys continue to see that from your other -- from the other companies you follow. So I think it's a little bit of interest rate abatement, but just overall more optimism in the custom home and then also the production markets.

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [68]

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And I would just add that we see nothing that says any of the fundamentals have changed in terms of demographics, population growth, the need for housing. As we talk about the pause that happened in Q4, I think to Mike's point, some of the muting of the interest rates, some of the adjustments that builders are making in terms of size and scale, I think all that is going to work its way through and those fundamentals at some point are going to take over.

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Operator [69]

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Our final question comes from the line of Kurt Yinger with D.A. Davidson.

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Kurt Willem Yinger, D.A. Davidson & Co., Research Division - Research Associate [70]

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Jim, you had mentioned as you moved through the year, moving to maybe more of a normalized gross margin, could you kind of give us a sense of a band of reasonable expectations? And just based on your commentary, it seems like the first quarter of '19 should still see pretty good year-over-year gross margin expansion. Is there any way to bucket that between maybe the benefits of the trend in lumber versus commodities declining as a percentage of revenue or your other productivity initiatives?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [71]

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Sure, Kurt. I guess there's probably 2 things to keep in mind as you think about our gross margins. I mean #1 is what are the more normal gross margins within each of our 4 product categories? And as I think we've certainly pointed out before, I mean the commodity lumber and lumber sheet goods category is the lowest gross margin category of our 4 historically and those are usually in the mid-to high teens. So certainly, over the last couple of quarters, we've seen extraordinarily high gross margins within that category. And that's what we think will start to come back towards a more normalized level over the coming months. So that's point one is what are the margins doing within each category. The second thing to keep in mind is you then kind of flip to what's our sales mix. And if there's some offsetting benefit if you will around the overall gross margin, it's that when prices come down, lumber becomes a smaller percent of our overall mix. In 2018, that was around 35% of our total sales because prices were so elevated. You could see by fourth quarter, it was all the way down to 32%. And that could continue to fall if lumber prices are lower, and therefore it's a smaller part of our mix, and that means that at least the overall gross margin percentage isn't as negatively impacted. All else being equal, our gross margin is better when lumber is the smaller part of our mix. And that certainly the expectation for 2019 verses '18.

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Kurt Willem Yinger, D.A. Davidson & Co., Research Division - Research Associate [72]

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Okay. Thanks, Jim. And would you expect that same sort of dynamic to play out in structural components? I mean, have those gross margins been extraordinarily high similar to the commodities?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [73]

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They are certainly elevated. I wouldn't say they're as extraordinarily high and obviously that's a part of the business whereas we said earlier it's much more of a service equation. And obviously, as we invest in automation, as we do other things, as we've talked about, those are other opportunities to improve those margins within the business. So certainly could be some comparative headwind I guess, but I think over the medium and long term, those are margins in the category that we would look to continue to expand.

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Kurt Willem Yinger, D.A. Davidson & Co., Research Division - Research Associate [74]

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Okay. And lastly, a lot of commodity producers have described lean inventories through the distribution channel. I'm wondering if that aligns with kind of where your own inventories are or how comfortable you feel with your level of volume that you have.

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [75]

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I mean where we were running and have been running our inventories relatively lean here in the latter part of 2018, just waiting to see where cost may bottom out. And we continue to do so as we sit there today. So we'll obviously have some seasonal build as we get a little further into the spring, but nothing out of the ordinary.

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Operator [76]

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Thank you. We have reached the end of our question and answer session. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.