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Edited Transcript of BMCH earnings conference call or presentation 6-Aug-19 12:30pm GMT

Q2 2019 BMC Stock Holdings Inc Earnings Call

RALEIGH Aug 9, 2019 (Thomson StreetEvents) -- Edited Transcript of BMC Stock Holdings Inc earnings conference call or presentation Tuesday, August 6, 2019 at 12:30:00pm 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

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Conference Call Participants

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* Christina Chiu

Barclays Bank PLC, Research Division - Research Associate

* 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

* Michael Glaser Dahl

RBC Capital Markets, LLC, Research Division - Analyst

* Min Chung Cho

B. Riley FBR, Inc., Research Division - Associate

* Noah Christopher Merkousko

Stephens Inc., Research Division - Research Associate

* Steven Ramsey

Thompson Research Group, LLC - Senior Equity research Analyst

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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 Second Quarter 2019 Earnings Conference Call. This call is being recorded today, Tuesday, August 6, 2019. Carey Phelps, Vice President 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; and Jim Major, our Chief Financial Officer, will discuss our key priorities and our operating results for the second quarter of 2019. 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 measure. 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, PowerPoint presentation 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 statements section in today's press release and in our SEC filings for various factors that could cause our actual results to differ in a material way from forward-looking statements and projections. As noted in our earnings release issued this morning, our results for the second quarter include the impact of an out-of-period provision for bad debt of $4.3 million. We have determined that the cumulative impact is not material to the current period or any previously issued financial statements. We are also reviewing certain internal control deficiencies, which is likely to result in a reporting of a material weakness in internal controls of our financial reporting. We are implementing corrective actions to remediate such internal controls.

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 thank you for joining us. We were pleased to report another quarter of strong results, driven by the successful execution of our strategy. Highlighting the resilience of our business model, regardless of market conditions or the margins we achieved through our improved product mix, our ongoing Lean Six Sigma-based productivity efforts and through the focused actions of our pricing and sourcing team as well as our significantly improved cash flow.

Specifically, for the quarter, we delivered nearly 9% growth in Millwork, Doors and Windows, mid-single-digit organic growth in our value-added product categories, continued volume growth in excess of 20% in our newest Ready-Frame market, increased gross profit and a strong 200 basis point improvement in gross margin.

$35.7 million of net income, adjusted EBITDA of $73.3 million or $77.6 million, excluding the one-time out-of-period item. Adjusted EBITDA margin of 8.2%, excluding the onetime out-of-period item and an 86% increase in cash flow from operation to $51.6 million.

Our team is making significant progress on each of our strategic pillars, which is outlined on Slides 5 and 6. Our pillar 1, organically grow our value-added products, services and higher-margin segments. While single-family starts declined 5.4% in our market, we are gaining share and outpacing those trends in our value-added product categories, with 4.5% organic growth in structural component and 5.3% organic growth in Millwork, Doors and Windows. In addition, we delivered strong 8.2% organic growth in our multifamily customer segment.

Pillar 2, drive efficiencies and enable outstanding customer service through the BMC Operating System and our operational excellence initiative. Introduced less than 2 years ago, the BMC Operating System is achieving exactly what we had hoped, labor efficiencies, promoting a safer work environment, process improvement and enhanced customer service as we are able to reduce lead time and increase our capacity. As a result, the BMC Operating System and our operational excellence efforts delivered in excess of $6 million in EBITDA benefits during the first half of the year and are expected to provide $12 million to $15 million for the full year. As we've highlighted on previous calls, we have 2 automated truss locations up and running in Atlanta and Austin, with 2 more under development in Salt Lake and Seattle. As a reminder, Salt lake will start-up this quarter and Seattle is expected to begin operations in time for the 2020 spring building season.

Over the next several years, it's likely we will find it compelling enough to add this technology in an additional 5 to 10 markets. However, even if a facility isn't selected for the more fully automated solution, we are upgrading equipment to provide more efficient, time savings and capacity-boosting equipment in a number of our door, truss and EWP manufacturing facilities. In addition to upgrading our equipment, we are utilizing the tenants of lean manufacturing to improve productivity and the efficiency of our processes.

During the second quarter, we completed more than 20 lean events company-wide, advancing our local capabilities in areas such as order-to-cash cycle times, yard layout, truck turnaround, inventory management and warehouse utilization and layout. In addition, we improved our on-time, in-full metric by 170 basis points over last year.

And finally, as evidenced by our strong margin performance so far this year, our pricing and sourcing teams are successfully adding rigor to their processes. While working to price competitively with all of our product lines, we are utilizing value-based pricing to ensure we are adequately paid for the service and value we provide. Meanwhile, internally, our managers are benefiting from increased transparency and insight provided through improved tools and analysis that are now provided consistently to the field.

Moving on to Pillar 3, build a high-performance culture with additional training incentives, including enhanced management training, sales training and Lean Six Sigma boot camp. Since the inception of these efforts, we have hired 58 management trainees, graduated 250 of our employees from our leadership development program and developed best practice council, each of which focuses on a particular specialty, such as structural component, Ready-Frame, installed services and Millwork. These councils are facilitating idea sharing and implementation across our markets to enhance our customer experience and drive growth in our higher-margin, value-added products and categories.

And finally, Pillar 4, pursue the right acquisitions to help us expand our geographies, increase our capacity and enhance our value-added offering. We were pleased to announce the closing of Kingston Lumber last week, which at $24 million in annual revenue, expands our footprint to the relatively more affordable west side of the Puget Sound and brings an enhanced customer mix of remodeling and custom builders to our Pacific Northwest operation.

All of the investments we are making in our equipment, processes, people and tuck-in acquisitions are in support of our efforts to grow our value-added products and higher-margin customer categories, while also ensuring we are efficient operator. The BMC operating system and operational excellence is now part of our culture and an important part of the way we do business, as we are investing to develop the leadership talent and organizational capabilities to execute our strategy over the long haul and ensure we deliver shareholder value.

I'd like to thank the 9,000-plus associates that make up our BMC team for their commitment to these efforts, their drive to deliver strong results and their continued execution of our strategy.

Before passing the call over to Jim, I'd like to highlight one of our valued long-time associates who truly embodies the BMC value. Jason [Astegard] was recently promoted to the role of outside sales rep in Orem, Utah, and achieved his first $1 million sales month in June. After joining the company in 2015, Jason has not only worked his way up here, but he has also served 24 years in the Army, Reserves and National Guard, deploying to both a Iraq and Afghanistan. He describes his most rewarding experiences, helping a child in Iraq, received a much needed heart surgery. Back home, he continues his community service as the Leukemia and Lymphoma Society Chairman for BMC's Salt Lake City market. One of his coworkers described Jason as the hardest working and most customer-service-oriented person he knows, truly the best of the best. We are exceptionally proud to call Jason a member of our BMC team.

With that, I'll turn the call over to Jim for a detailed look at our second quarter results and our full year outlook.

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [4]

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Thanks, Dave. Before I review our second quarter result, I want to comment briefly on the out-of-period bad debt item we described in this morning's press release. During the second quarter, we determined that one of our local credit managers who has since been terminated, violated the company's credit policy by manipulating certain open customer invoices to prevent them from aging property. As a result, we did not pursue more vigilant collection activities in a timely manner, and these invoices, which still appeared to be within agreed terms, were not included in our provision for bad debts.

We recorded $4.3 million of out-of-period bad debt expense in our second quarter results and have determined that this amount is immaterial for the current quarter and all previously reported periods. We've seen no evidence that this issue existed beyond the local operation and individual employee in question, and we do not expect this matter to have an impact on future periods. Our management and our Board take this matter very seriously. We will learn from it, and we are working diligently to remediate the underlying control weakness as quickly as possible. After more than 20 years with the company, I've not seen a situation quite like this one. It's extremely disappointing, and in no small part because it distracts from the tremendous results we delivered in the second quarter.

So on that note, I'd like to move forward and talk about those many highlights, starting with our strong gross margin. With a 200 basis point year-over-year improvement, our 26% gross margin helped us deliver substantial EBITDA margin and cash generated from operations during the quarter. Following record-high lumber prices a year ago, net sales for the second quarter decreased 5.2% to $946.4 million, as shown on Slide 7. We estimate that net sales decreased 8.9% from commodity-related price deflation, of which 8% related to the impact on our lumber and lumber sheet goods product category, while 0.9% related to our structural component product category.

In addition to the impact of commodity-price deflation, net sales also decreased year-over-year by 1.1% due to the disposition of our Coleman Floor business in 2018. These decreases were partially offset by an increase of 2.8% from our acquisitions in the Charlotte market and an increase of 2% from other organic growth. While 2% organic growth in the second quarter and 2.7% year-to-date organic growth is below our longer-term goals, we believe it represents a significant outperformance to market, as single-family starts across our footprint were down approximately 8% in the first half of 2019 as compared to the prior year.

Looking at our results by product category, given the significant year-over-year decline in commodity prices, our sales of lumber and lumber sheet goods declined 23.4% during the second quarter. Meanwhile, demand for our value-added products continued to increase. Millwork, Doors and Windows was our fastest-growing product category, up 8.8% as compared to the prior year, in large part due to continued strength in our multifamily business and the acquisition of Barefoot and Company in February.

Other organic growth within structural components totaled 4.5%, as adoption of prefabricated solutions continues to gain traction. Ready-Frame recorded $60.3 million in sales, which was up slightly from a year ago, as volume gains were offset by commodity deflation and lower starts activity in California and the Pacific Northwest. Excluding those markets, organic volume growth in Ready-Frame increased over 20% versus the prior year, and we continue to see increasing customer adoption in many of our markets.

Despite the deflationary impacts on our top line, gross profit increased 2.6% to $245.8 million for the second quarter, while gross margin improved 200 basis points to 26%. This result reflects a 320 basis point year-over-year improvement in gross margin within the lumber and lumber sheet goods category, and a 300 basis point improvement within structural components, as we have maintained pricing discipline and captured benefits from our sourcing and manufacturing productivity initiatives, including the increasing use of automation and equipment upgrades within our structural components and Millwork operations.

SG&A expense during the second quarter rose $11.6 million to $181.4 million. However, much of this increase was either onetime in nature or related to our recent acquisitions. $4.3 million of the increase related to the out-of-period item, I mentioned earlier, while $4.4 million of the increase related to expenses at our recently acquired companies. Excluding both of these items, our underlying SG&A was up 1.7% or $2.9 million primarily related to higher health care costs and employee wage inflation.

For the quarter, SG&A as a percentage of sales was 19.2% or 18.7%, excluding the out-of-period item compared to 17% a year ago. This increase was primarily due to lower revenues caused by commodity price deflation.

Net income decreased to $35.7 million or $0.53 per diluted share as compared to $0.60 per diluted share in the same period last year. The estimated after-tax impact of the out-of-period item was $3.3 million or $0.05 per diluted share. Adjusted net income increased -- or decreased to $39.4 million or $0.59 per diluted share compared to $0.64 per diluted share in the prior year. Adjusted EBITDA decreased 7% to $73.3 million compared with $78.8 million a year ago, as the impact of commodity price deflation and the out-of-period item recorded during the quarter was partially offset by strong gross margins, organic growth and acquisitions. Adjusted EBITDA margin was a solid 7.7% for the quarter or 8.2%, excluding the out-of-period item.

During Q2, we delivered another quarter of strong operating cash flow, up 86% to $51.6 million as compared with a year ago, as we saw significant benefits from the decline in prices for lumber and lumber sheet goods and saw improved inventory turns. Year-to-date, we've generated $129.3 million in operating cash flow, more than doubling last year's level. In addition, in late May, we successfully increased the size of our bank revolver by $50 million to $425 million, and extended its maturity by 4 years to 2024, thereby unlocking additional liquidity to fund our strategic growth opportunities.

Total liquidity, which also includes excess availability on our revolver was $528.2 million at June 30. This included cash and cash equivalents of $160.5 million. With a net debt to LTM adjusted EBITDA ratio at June 30 of just 0.7x, our balance sheet remains one of the strongest in the industry and provides us with significant flexibility as we pursue our growth strategies.

Capital expenditures during the second quarter, net of proceeds from the sale of property equipment, real estate totaled $28.7 million. As a reminder, we expect to spend between $80 million and $90 million of CapEx in 2019. And over the longer term, are targeting approximately 1.5% to 2.5% of sales in total CapEx annually.

Since the beginning of the year and including the Kingston acquisition, we have invested over $100 million into our capital asset and acquisition programs. This higher level of investment, combined with a strong pipeline of future opportunities and a recent improvement in our share price led to a slower pace of share repurchases in the second quarter. As of today, we have $55.7 million of capacity remaining under our repurchase authorization, and we'll continue to utilize that opportunistically.

Turning our attention to our full year expectations for 2019, which we have outlined on Slide 9. While starts in the first half of 2019 registered year-over-year declines, we continue to believe that second half housing start comparisons will become more favorable. Given these assumptions and our expectation that we will continue to drive growth in our value-added products, we expect to achieve full year 2019 organic net sales growth in the low single digits, excluding the impact of commodity deflation.

In addition to organic growth, we expect our recently completed acquisitions, including Shone, Barefoot, Locust and now Kingston and net of the Coleman Floor disposal deliver between 1.75% and 2.25% growth in our total net sales. And based on full year -- our full year lumber price assumption of $340 to $365, we expect a 7% to 8.5% headwind from commodity-price deflation to our total net sales for the full year and an 8.5% to 11.5% negative impact for the third quarter. Taken together, these assumptions are expected to result in full year 2019 net sales of $3.5 billion to $3.65 billion, which is unchanged from our prior earnings call.

Our productivity efforts, pricing discipline and improved product mix have allowed us to maintain gross margin well above recent averages. We still expect modest sequential declines in gross margin for the remainder of 2019, but less than we indicated on our prior earnings call. As a result, we are raising our expected full year gross margin to the range of 25.5% to 26.2%. Combining our outlook for both net sales and gross margin and with a continued focus on expense management and productivity, we are increasing our outlook for the full year of 2019 adjusted EBITDA to $238 million to $258 million.

I'm excited about the way our team is executing. July sales trends remain healthy, and we are making progress with our productivity initiatives. As we head into the back half of 2019, we remain poised to deliver solid results for the year and are well positioned for longer-term growth.

So with that, let me turn the call back over to Dave.

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

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Thanks, Jim. I'm very pleased with our progress to date, executing against our strategic pillars. As our customers are increasingly recognizing us as a leader in innovation and as a solutions provider, we're gaining share in our value-added product categories and outpacing the broader market.

Over the long term, we expect to continue this outperformance in our value-added category. We also believe that the underlying fundamentals, such as employment levels, low mortgage rates, continued growth in household formations and improving home builder order trends should continue to support growth in housing for some time to come.

Our team is driving both financial and operational improvements throughout the business. We are investing in our people to develop and retain our talent as well as to assist in the integration of the BMC operating system and operational excellence into our culture.

And finally, as we have highlighted on Slide 10 and 11, we are significantly ramping up our efforts on our fourth pillar, to complete strategic tuck-in acquisitions in order to enhance our market position or geographic footprint, provide additional capabilities and improve our product and customer mix.

Excluding our large merger, since the beginning of 2015, we have completed 8 tuck-in acquisitions that are now producing annualized revenue of approximately $500 million and adjusted EBITDA of approximately $40 million. We've identified more than 400 peer companies to find potential acquisition targets and categorized them according to annual revenue, ranging in size from $25 million to just over a dozen peers with revenue over $1 billion. Specifically, approximately 300 potential acquisitions were identified to have between $25 million to $100 million of annual revenue. 68 potential companies to acquire, have $100 million to $250 million in annual revenue and another 48 larger peers have annual revenue ranging from $250 million to over $1 billion.

During the past 18 months, we've assigned priorities to each peer company and made nearly 100 outbound inquiries to assess interest level and potential fit with BMC. While also receiving approximately 50 inbound inquiries during that same time period. With this level of ongoing dialogue, we feel confident that we have a solid pipeline of opportunities, and we'll remain disciplined to ensure we make intelligent buying decisions.

Acquisition growth is a large and very important opportunity for us. We continue to expect to add between $100 million and $250 million on average in top line sales from tuck-in acquisitions annually, while maintaining our discipline and the flexibility to complete a larger deal, should the right opportunity arrive.

Successful execution of our strategy has been driving our strong results this year. During the first half of 2019, we delivered volume growth well above single family starts, produced meaningfully higher gross margins as compared with a year ago. Drove significant productivity and efficiency improvements through our operating system and have now added over $129 million in annualized top line revenue from tuck-in acquisitions with a solid pipeline of additional opportunities. As a result, our underlying EBITDA margin for the second quarter was above 8%.

I am confident that our momentum will continue. Our team is energized and focused, and I look forward to reporting our continued progress and achievements on our next call.

With that, I thank you, again, for joining us today, and we'll ask Shantel, to please lead us in the Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Matthew Bouley, Barclays.

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Christina Chiu, Barclays Bank PLC, Research Division - Research Associate [2]

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This is actually, Christina Chiu on for Matt. I just want to ask on gross margins, what do you think is the normalized gross margin at this stage? And how do you expect margins to progress in the back half?

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

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Yes. Thanks. As we said on the call, we expect some moderate sequential declines in gross margin over the back -- 2 quarters of the year and for the full year expect that to put us somewhere in the 25.5% to 26.2% range. I think if you think longer term and assuming lumber prices continue to stay somewhere in the mid-300s, as they've been trading over the course of this year that, that longer-term margin prior to any additional sales mix improvement in our business would probably be around 25% to 26%.

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Christina Chiu, Barclays Bank PLC, Research Division - Research Associate [4]

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Okay. And then can you also expand a bit on the out-of-period cost of $4 million that you had in the quarter. Do you think that is identified as a material weakness that it will result in any cash cost spending from the litigation?

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

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We're still finishing that assessment. And -- so -- but if it is ultimately determined to be a material weakness obviously we'll talk a little bit more about our remediation plans in the upcoming quarterly filing. At this point, though, we don't think it will result in any significant cash cost to remediate that issue.

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Operator [6]

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Your next question comes from Trey Morrish, Evercore ISI.

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James A. Morrish, Evercore ISI Institutional Equities, Research Division - Analyst [7]

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Great job, Dave and Jim, on the quarter. Fantastic. Really, really good to see. I wanted to ask about the gross margin, but a little bit differently, the Structural Components segment, and it was a 300 bps year-over-year improvement, as you said, in the margin. That's a bit down from last quarter's 570. But I'm just wondering the sustainability of that segment specifically, is there something underlying going on in that Structural Components business that you're able to see a structurally higher margin? Or is it kind of getting the benefit mostly from the lumber deflation that the lumber and sheet good segment as well?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [8]

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Yes. Trey, a couple of points there. I think, number one, the year-over-year improvement is going to start to decelerate, if you will, because we're coming up against the more difficult comps. We're just now lapping kind of the peak lumber prices or lumber index costs from last year. So we started to see those improvements in the back half of each year, and therefore, the year-over-year improvement is going to continue to decelerate. But sequentially, those margins remain, certainly, quite healthy and improved relative to the multiyear averages. And we do see that both as a structural benefit, higher demand for Structural Components generally as more and more builders adopt those practices into their building processes. And then certainly, some of the commodity cost benefits have been helpful as well.

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James A. Morrish, Evercore ISI Institutional Equities, Research Division - Analyst [9]

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Okay. And then thanks for giving all the color on the potential M&A targets out there but I'm wondering if you could talk about the potential and likelihood of a larger deal relative to several smaller deals? And do you favor one over the other?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [10]

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I think. Good question, Trey. Let me just add a little bit more color to my comments on the call. I think, and specifically, that's kind of why we outlined the pond in which we're fishing. At the moment, if you look at the number of opportunities that we have, it's certainly in that $25 million to $100 million range. If you look at the nature of the acquisitions that we've done over the past several years, and they tend to be in that range. I love the ones that we've done this year. We've added capability in Charlotte and now with Kingston out in the Pacific Northwest. I think we're finding the right opportunities. Large deals come along on a rare occasion, I like our positions for the right thing happen, but we're focused on the many opportunities that we have that tend to be smaller in nature right now.

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Operator [11]

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Your next question comes from Trey Grooms, Stephens.

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Noah Christopher Merkousko, Stephens Inc., Research Division - Research Associate [12]

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This is actually Noah Merkousko on for Trey Grooms. So just looking at the Structural Component sales, it looks like they were down 40 bps in the quarter, but up organic. If you can maybe talk about that, is that just the impact from inflation? And then maybe if you could just give a little bit of color on what you're hearing from the homebuilders that are using some of these value-added products and services.

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [13]

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Yes. Noah, you're correct that sort of the difference between the total change in sales dollars and Structural Components and what we broke out in the release is sort of the other organic change is basically deflation, we are starting to see because of the amount of wood that goes into some of those product categories, at least a little bit of a price decline relative to last year's higher prices. But as we noted, still better gross margins overall. In terms of just builder adoption generally, I mean labor is still tight. And I think that's certainly -- go ahead.

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [14]

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I think some of the underlying fundamentals that we see in the market, we've commented on time and time again, like labor, just the challenges around labor. I think that's going to persist for a long time to come. The shift we've seen in the company across the last couple of years, relative to Structural Components, we're confident that's going to continue. We're continuing to invest in things like automation, as you've heard. And importantly, and we broke out that organic growth in structural components, I think we're well outpacing the minus 5% that we've seen in terms of housing starts across our footprint. And I think that just speaks to the rate of adoption that we're seeing in some of these value-added categories, particularly Structural Components.

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [15]

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Yes. And I'd actually add one more thing that we probably don't talk about enough, as we continue to invest in the manufacturing equipment and the design software that underscores that stuff, the quality of the product continues to get better and better as well. And so I think that resonates with builders to help them get the maximum benefit from adopting those products.

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Noah Christopher Merkousko, Stephens Inc., Research Division - Research Associate [16]

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That's definitely helpful. And then just one quick follow-up. Given your expectations for lumber to maybe trade within that mid-$300 price range. How should we be thinking about the SG&A and expense in the back 2 quarters of the year. Do you also -- given that the way wages are paid with lumber inflation, should we expect a sequential decline in SG&A?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [17]

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Well, generally, you won't see a sequential decline from Q2 to Q3, those quarters tend to be pretty similar to each other. But as you move into the fourth quarter, then you certainly see some seasonal and sequential decline in variable costs.

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Operator [18]

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Your next question comes from Steven Ramsey, Thompson Research Group.

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Steven Ramsey, Thompson Research Group, LLC - Senior Equity research Analyst [19]

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Thinking about what you said on July trends being healthy. Can you maybe clarify? Are they better than what you saw in Q2 or similar levels? Any thoughts on clarifying the July activity?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [20]

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Sure. I mean I think typical, as I said, with respect to SG&A, that generally holds true on sales as well. Typically, Q3 is either flat to maybe slightly down from Q2. Just by nature of kind of how seasonally the building season unfolds. And certainly, July trends are very much in line with that normal seasonality and remain healthy.

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Steven Ramsey, Thompson Research Group, LLC - Senior Equity research Analyst [21]

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Great. And maybe to dig in on pricing as a pillar of improvement, can you discuss where you're working to drive better pricing discipline? Are there certain products or services where the gap is bigger than others? And is this inclusive of lumber or are these opportunities outside of the lumber products?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [22]

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I think we've got -- I'll start and Jim can add some color. I think we've got opportunities broadly across the business. And as we've ramped up our visibility to the field around pricing opportunities over the last several quarters, we're getting traction and action really across all product categories. And that was really the intent. Just providing that extra visibility and where those opportunities might be. And I think we've got a lot of good momentum. We're still learning and rolling out processes, but we're ramping that effort up. And I think we have a lot of opportunity there ahead.

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [23]

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Yes. I would just add that most of what we sell is on kind of bid-quote basis. So improving the accuracy, the speed with which we can deliver those bids and quotes to our customers, not only has some pricing benefit, but hopefully has some benefits in terms of the percentage of business overall.

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Operator [24]

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(Operator Instructions) You next question comes from David Manthey from Baird.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [25]

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First off, Jim, maybe, if my notes are right here, you have an extra selling day in the third quarter. First, is that the case? And then second, if you could just remind us, talk generally about what that might mean for the complexion of that quarter?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [26]

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You're right, Dave. On a year-over-year basis, we'll have one more day in Q3 than we did in the prior year, which is making up for a day that we lost back in the first quarter. So the year-to-date will be sort of back to even by the end of the third quarter, I think. I may be off a day here, but I think there's -- it pulls down to something like 63 days instead of 62 or 64 instead of 63 selling days, so you're talking about a 1.5% impact.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [27]

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Right. Okay. And also Jim, we haven't talked much about contribution margin lately, just given the dynamics of lumber.

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

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All right.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [29]

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If prices stabilize here, like they have been, we could get to a point by the fourth quarter where the year-to-year comps are more normal. And I'm just wondering, is there any change to your 10% to 15% contribution margin view? Are you still comfortable with that range?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [30]

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I think on a longer-term basis and assuming prices stay more in, what is now, the longer-term averages for lumber, 10% to 15% is still something we're comfortable with. I don't know that you'll necessarily see that work in the fourth quarter, though, because I believe our gross margin in that quarter was pretty much the high watermark at 26.7%. So we'll start to comp some much more difficult numbers on the gross margin line, at least during the short term. That's all incorporated into our 2019 guidance, obviously. And as I said, longer term, as you start to think about 2020 and beyond, then hopefully, we get back to those more normal ways of thinking about incremental margins and still feel good about that 10% to 15%.

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David John Manthey, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [31]

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Okay, sounds good. And finally, if you could remind us on how high you'd be willing to take your leverage ratio at this point in the economic cycle.

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [32]

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I mean we said 2 to 2.5x for quite a while now. And obviously, we're well below that target range, which gives us a good bit of dry powder to do the tuck-ins we're talking about, but really no change in that longer-term view.

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Operator [33]

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Your next question comes from Jay McCanless, Wedbush.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [34]

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Wanted -- first question I had is, it looks like you guys are taking some pretty meaningful market share from other players in the distribution business. And just wanted to get your thoughts on, who do you think you're taking the share from? And is there going to be any kind of blowback as it looks like probably starts, as you guys said, starts are probably going to rebound in the back half of this year. Just a little conversation about what competitive environment looks like?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [35]

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Yes. I'll start here. I think the competitive environment is the same as it's always been. I think it's a very competitive market out there. And as you've heard and understand, we're squarely focused on adding value to our customers. Whether it's no work, whether it's our structural components, ready frame, and we're getting great traction, really broadly across our geography. And we expect that to continue. I don't think there's any one pocket of competitors that share is coming our way from, I think it's pretty broad-based and across most of our major geographies. And that's clearly, where our team is focused. It's really stepping on the gas relative to where we think we can add most value for our customers, help them solve their productivity challenges and become more efficient in the entire homebuilding process, and I feel good about our momentum.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [36]

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That's great. And then the other question I had with mortgage rates continuing to move lower over the last couple of months. What has happened with private market valuations? Are you guys having to walk away from more deals and/or is this people seeing this is, probably -- maybe the last big push down in mortgage rates, so they better sell, I'd be interested to get your take on that?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [37]

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Yes, I'm not sure, we see a whole lot of impact from that. It's not a particularly liquid market I guess, and not one that tends to react particularly quickly to those types of things that, generally speaking, the conversations we're having are similar to conversations we've been having in recent years. And I think a lot of new wins, a particular opportunity really bolts down the strategic fit, cultural fit and in addition to dollars. And so we like where we sit in that regard because of all the efforts, all the kind of sweat equity we've been putting into this process over the last 18 months to build those relationships.

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Operator [38]

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Your next question from Kurt Yinger, D.A. Davidson.

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Kurt Willem Yinger, D.A. Davidson & Co., Research Division - Research Associate [39]

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Can you just talk about how you would typically think about a year 1 and 2 ramp for a new trust facility? And then as you look at the potential 5 to 10, would that be more greenfield or kind of similar to what I believe you did in Atlanta, where you were kind of building on to an existing facility.

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [40]

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Yes. I think it really depends upon the market. I think the 4 markets that we've got in play. We've got a combination of greenfield activity as well as retrofitting of existing trust manufacturing lines. And it really depends on where those -- we're going to go to where the opportunities are. Where we think we've got the opportunity to drive that structural component into the market, we've got probably already a good presence in terms of market share and ample opportunity to continue to drive growth. And the ramp-up on those is, it probably takes us 6 to 9 months to get things fully, from start-up to operations when we're talking about automated capabilities. But it's just part of the natural progression. So we're really pleased with the investments we've made so far. We're excited about the opportunities we have ahead, and that's an area we're fully committed to continuing to invest in.

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Kurt Willem Yinger, D.A. Davidson & Co., Research Division - Research Associate [41]

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Got it. Okay. And then do you guys -- when you -- if you look at the 3 acquisitions you've done this year? I mean are there any synergies from you being able to supply those businesses with some of the manufacturing capabilities you would have in those markets already? Or how do you think about what you bring to those businesses?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [42]

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Yes. I think for sure that's one of the benefits of, sort of, adding to our local scale with both the Seattle acquisition and the Charlotte acquisitions, we'll be able to leverage their sales force over time to sell more truss, to sell more millwork out of our production facilities in those markets.

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Kurt Willem Yinger, D.A. Davidson & Co., Research Division - Research Associate [43]

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Okay. And then just lastly, how should we think about sort of Ready-Frame growth between more mature markets and newer ones? And do you think it's getting easier sort of in those new markets, given the scale of that business and your marketing push?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [44]

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I wouldn't say it's getting easier. I would say that our team is getting more confident where they've got the experience with it. And as we continue to play out that value proposition in front of the customers. We're continuing to get traction over time. And as we said here on the call, 20% growth in the quarter in those less mature markets, that's exciting, but it's also what we expect based on the amount of effort and energy, as you point out, that we're putting behind it. So we're pleased with it. We think there's a lot more to do as we go forward.

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Operator [45]

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Your next question comes from Mike Dahl, RBC Capital Market.

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Michael Glaser Dahl, RBC Capital Markets, LLC, Research Division - Analyst [46]

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So I wanted to just talk high-level expectations, I think, as you noted and we've all seen and builder orders have inflected pretty nicely into positive territory, but you guys are impacted with a bit of a lag there. So given that and some of the choppiness also in home improvement spend. Can you help us frame what your market growth expectations are for the back half that your guidance is reflecting?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [47]

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Yes. I think to your point, Mark, or Mike, there's always a bit of a lag there in terms of starts, and I think we've quite cautioned people in the past to think more in terms of trailing 9 or 12-month start numbers as opposed to any particular month or quarter. And because of that, even though, as you said, orders are starting to pick back up nicely. And hopefully, that translates into stronger starts in the back half of the year. I think our guide for the balance of year is somewhat steady state in terms of a few points of organic volume growth in the back half. We wouldn't necessarily expect that inflection in orders to have a meaningful impact until maybe we get into the early part of next year.

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Michael Glaser Dahl, RBC Capital Markets, LLC, Research Division - Analyst [48]

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Okay. And within that, do you think there's potential for Structural to reaccelerate more towards the high single digit? Do you think it should -- it's really for the next couple of quarters is going to remain from a volume standpoint, something more in the mid singles?

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [49]

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We are closer to 5% this quarter. And I guess we're right at 5% year-to-date. So again, hopefully, steady state in that regard as well. There's some seasonality to components in lumber too. You don't have quite as many starting up in the back months of the year as you might in the spring. And so that would be a little bit of a challenge, perhaps to accelerate in the back half. But again, I think all these orders and improvements if they continue to the back half of the year should set up us really nicely for the first part of next year.

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Michael Glaser Dahl, RBC Capital Markets, LLC, Research Division - Analyst [50]

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Okay. And then my last question, just shifting gears back to M&A. Helpful in terms of outlining some of the process and pipeline. It seems like step one is really just identifying based on revenue bucket. But obviously there's a lot more layers that you then go through to narrow down the target list. So can you give us a little more color on -- as you work down the list, what your -- remind us what the criteria are? And then when you get to that 100 or even now down further what the realistic kind of pipeline is based on all those other fit criteria.

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David E. Flitman, BMC Stock Holdings, Inc. - CEO, President & Director [51]

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Yes, I'll just start, and it's going to sound like I'm dodging your question, but I'm not, they're unique, right? Each market is unique. Each of these opportunities is unique. Many of them are family-owned, multigenerational businesses and they're concerned about the future of their associates. We're thinking about the capability as an earlier question asked, that we can take into that spaces, but importantly, also the value that the acquisition target can bring into our company, whether it's footprint or additional capability. But as Jim said earlier, I think the biggest factor in many of these being successful is the cultural fit. They're concerned about the future of something that they might have built over a couple of generations in their families. We're also concerned because, when we target an acquisition, we really look for strong management teams. We want them to stay. We're buying them for a big part of what they've built, not only with their own associates. But importantly, with the customer relationships that they worked hard together over a number of years. That's really, really important for us. And so it's a number of those sort of factors. And there's no magic checklist. Sure, there's a few things that we look at. But I would put a lot on that cultural fit and what we bring to each other in terms of added capabilities over time.

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Operator [52]

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Your next question comes from Keith Hughes, SunTrust Robinson Humphrey.

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

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I just wanted to, I guess, a clarification on the Ready-Frame numbers, I believe you said, it was up 20%, excluding commodities, taking out some of the difficult geographies. Can you just kind of give us what geographies those were and kind of relative growth rates between the 2?

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

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Yes. I think, as you'll probably recall, Keith, our most established markets for Ready-Frame because it's where the product was originated in the Coastal -- West Coast Markets, California and the Pacific Northwest. And so we've got a little bit of a math problem, if you will, with fact that does happen to be the markets where starts have defined the most here in the first half of the year. So we've seen some pullback in those markets. And obviously, we've been hit by deflation as well. But when you take out those 2 factors, the balance of our Ready-Frame business is up over 20% on a pre deflation basis.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [55]

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And maybe say what you're talking in Seattle, which is where they started?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [56]

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Yes, Seattle. That's right. Seattle. And then a couple of our California markets. And obviously, we're seeing starts down in the teens in those areas.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [57]

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Is that now -- is that still over 50% of what Ready-Frame does is in those western months?

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [58]

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No, no. We've got a broader business than that today, but obviously, it's still -- they're still among the leading markets. And so with the starts being down more than the company averaged and it being a higher mix of the overall Ready-Frame sales, it made the overall sales dollars closer to flattish. In addition to those deflationary impact.

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Operator [59]

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Your last question comes from Alex Rygiel, FBR & Company.

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Min Chung Cho, B. Riley FBR, Inc., Research Division - Associate [60]

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This is Min Cho for Alex. I just have a quick question on your remodeling business. Obviously, revenues are down. But if you could talk a little bit about what the volume trends have been kind of in the second quarter and in the first half of the year, expectations going forward? And if there are any specific geographic trends or anything you can talk to on the remodeling side.

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [61]

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Sure. Yes. I think if I refer you back to the press release, we tried to take out the deflationary impact on all of our customer segments. And so remodeling in second quarter was pretty close to flattish, which is actually an improvement in trend from the first quarter. Here in the first half, we've actually been challenged with some comparisons in the Houston market. In the first half of last year, we saw a real bump and sort of spike in remodeling sales in Houston following the Harvey Hurricane there. And so as that spike is starting to get lapped. We saw a little bit of an improvement there in trend in the second quarter, and would hope to get back to at least some level of volume growth in the back half of the year. I wouldn't say remodeling growth generally is kind of in the low to mid-single digits from a macro perspective. So not quite as strong as perhaps it was in years prior, but still a good healthy part of the market for us.

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Min Chung Cho, B. Riley FBR, Inc., Research Division - Associate [62]

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Excellent. And then just quickly, I mean obviously, given the good expectations for the second half of this year and your guidance, it sounds like backlog is trending pretty positively. But if you can provide any additional details about backlog.

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James F. Major, BMC Stock Holdings, Inc. - Executive VP, CFO & Treasurer [63]

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Backlog is a little squishy. And to me, just talking generally around the business. I mean backlog is always a little squishy for us, just because it's a relatively short-cycle business in terms of what we participate in. But again, based on what we see in order trends, based on conversations that we have with our customers, we expect a good healthy third quarter and kind of the normal progression of seasonality here over the balance of the year. And hopefully, those higher orders translate into a little stronger growth going into next year.

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Operator [64]

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This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.