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Edited Transcript of SUM earnings conference call or presentation 6-Feb-19 4:00pm GMT

Q4 2018 Summit Materials Inc Earnings Call

Denver Feb 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Summit Materials Inc earnings conference call or presentation Wednesday, February 6, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian J. Harris

Summit Materials, Inc. - Executive VP & CFO

* Karl H. Watson

Summit Materials, Inc. - Executive VP & COO

* Thomas W. Hill

Summit Materials, Inc. - Founder, President, CEO & Director

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Conference Call Participants

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* Adam Robert Thalhimer

Thompson, Davis & Company, Inc., Research Division - Director of Research

* Brent Edward Thielman

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Collin Andrew Verron

Jefferies LLC, Research Division - Equity Associate

* Jeffrey Stevenson

Longbow Research LLC - Research Analyst

* Jerry David Revich

Goldman Sachs Group Inc., Research Division - VP

* Kathryn Ingram Thompson

Thompson Research Group, LLC - Founding Partner, CEO and Director of Research

* Kevin Lee Money

Cleveland Research Company - Senior Research Analyst

* Michael Benjamin Eisen

RBC Capital Markets, LLC, Research Division - Senior Associate

* Michael Glaser Dahl

RBC Capital Markets, LLC, Research Division - Analyst

* Rohit Seth

SunTrust Robinson Humphrey, Inc., Research Division - Associate

* Scott Evan Schrier

Citigroup Inc, Research Division - Senior Associate

* Stanley Stoker Elliott

Stifel, Nicolaus & Company, Incorporated, Research Division - VP & Analyst

* Timothy Ian Daley

Deutsche Bank AG, Research Division - Research Associate

* Trey Grooms

Stephens Inc., Research Division - MD

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Presentation

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Operator [1]

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Greetings, and welcome to Summit Materials Fourth Quarter 2018 Earnings Conference Call. (Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Brian Harris, CFO. Please go ahead, sir.

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Brian J. Harris, Summit Materials, Inc. - Executive VP & CFO [2]

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Good morning. This is Brian Harris, and I would like to welcome you to Summit Materials Fourth Quarter 2018 Results Conference Call.

We issued a press release before the market opened this morning, detailing our fourth quarter and full year results.

This call will be accompanied by our fourth quarter 2018 investor presentation and an updated supplemental workbook highlighting key financial and operating data, both of which can be found in the Investor section of our website.

I would like to remind you that management's commentary and responses to questions on today's call may include forward-looking statements, which, by their nature, are uncertain and outside of Summit Materials' control.

Although these forward-looking statements are based on management's current expectations and beliefs, actual results may differ in a material way.

For a discussion of some of the factors that could cause actual results to differ, please see the Risk Factors section of Summit Materials latest Annual Report on Form 10-K and subsequently filed quarterly reports on Form 10-Q, which are filed with the SEC.

Additionally, you can find reconciliations of the historical non-GAAP financial measures discussed in today's call in this morning's press release.

Today's call will begin with remarks from Tom Hill, who will provide an update on our business and market conditions through the year and our outlook for 2019, and then I will provide a financial review.

At the conclusion of these remarks, we will open the line for questions.

And with that, I'll turn the call over to Tom.

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [3]

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Good morning, everyone, and thank you for joining our call.

Turning to Slide 4 of the presentation, let's start with a recap of Summit's full year 2018 financial results.

Net revenue grew at 9%, primarily due to acquisitions as Summit integrated 13 materials-based companies, expanding our geographic reach and strengthening our local market positions.

Organically, our aggregate-based businesses experienced modest growth, led by low single-digit price increases as well as ready-mix volume improvement. However, this top line improvement was offset by a decline in our Cement segment.

Despite solid demand trends in our public and private end markets, adjusted EBITDA fell well short of expectations and declined by 6.8% from 2017. Excluding acquisitions, the decline was 13.3%.

As described in our Q3 earnings call, our operations encountered significant challenges throughout 2018. Severe weather conditions persisted throughout the year continuing into Q4, with Texas experiencing its wettest fall on record.

In addition, we encountered rapid cost inflation, which particularly impacted our products line of business.

Our price increases primarily announced in late 2017 were insufficient to recover these increased costs.

Finally, our Cement segment underperformed expectations on both volume and price, due to a combination of competitive pressures and poor weather with a cold, wet spring, extensive fall rain and an early winter in the upper Midwest.

Looking ahead to 2019, we forecast a meaningful recovery in adjusted EBITDA, with an estimated range of $430 million to $470 million.

Anticipated organic growth in both volume and price is supported by higher backlogs to start the year and growing private and public end markets.

Margins are expected to improve through both proactive cost-control measures and the operational benefits of our 2018 capital projects.

A substantial reduction in capital deployed, with CapEx anticipated to return to a more normal 7% to 8% of net revenue, will support deleveraging.

Turning to Slide 5. We estimate that weather had an adjusted EBITDA impact of $35 million to $45 million in 2018.

Adverse weather affects our business through volume, price and cost, and the impact is difficult to make up due to the seasonal nature of our business and capacity constraints.

We expect that improved weather in 2019 will support positive organic volume and price growth in all lines of business and contribute to productivity gains.

Margins are expected to increase in 2019 for 2 primary reasons: first, we have announced more aggressive price increases in all lines of business and are optimistic about improved realization in this inflationary environment. These increases are anticipated to at least offset 2019 costs, which are expected to grow again, but at a slower pace than last year. Second, productivity is expected to improve with better weather and contributions from our 2018 capital projects.

Lastly, we expect to see a market improvement in our Cement business, which underperformed in 2018.

While our plants ran at world-class production levels, we realized only a very modest price increase of less than 1% year-over-year as a result of the late start to the season, heavy fall rain and flooding and increased competitive pressures.

For 2019, $8 to $10 per ton price increases have been announced in our markets, generally effective April 1.

We are optimistic about achieving significantly greater price realization than we did in 2018, supported by both our customers' demand outlook and third-party market research.

Turning to Slide 6. We are positive on the U.S. construction cycle and anticipated demand across all end markets, encouraged by local dynamics and the fact that U.S. aggregates and cement consumption are still well below peak levels and long-term trend lines.

On the residential side, we continue to see stable growth in our top markets. Although certain U.S. markets are starting to overheat, we believe that Summit's markets are more mid-cycle.

In our top metro markets, single-family permits and months' supply of housing inventory remain well below their peaks and long-term averages, respectively.

Fundamentals such as high employment, low interest rates and reasonable affordability remain in place and should lead to continued steady growth.

On the nonresidential side, the positive momentum of the last few years should continue into 2019 and beyond. U.S. construction put in place grew throughout 2018 and architectural billings increased every month, with the Midwest reporting particularly strong conditions to finish out the year.

It is also worth noting that our business is focused on the low rise commercial work that generally follows residential construction, albeit with a 12- to 18-month lag, and we have little-to-no exposure to the more volatile high rise and office construction markets.

With regard to the public end markets, we believe the funding outlook remains positive. At the federal level, the Senate and the House Appropriations Committee have both approved proposals that increase funding for the Highway Trust Fund in fiscal 2019.

Total federal highway funding is expected to approach $50 billion in fiscal 2019, up approximately 14% from fiscal 2017.

Numerous states have been implementing their own self-funding mechanisms. Since 2013, 27 states, including 11 in which Summit operates, have raised or adjusted their gas taxes to increase transportation funding.

Additionally, since 2009, approximately 1,300 transportation ballot measures have been passed throughout the U.S. As a result of increased state-level funding over the past few years, the lettings in several of our key states hit record levels in 2018, and we anticipate even further increases in 2019.

Looking further ahead, ARTBA forecast U.S. highway bridge and tunnel constructions spend to grow at a 2.4% CAGR through 2023.

With that, I'll turn the call over to Brian for a discussion of our financial results.

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Brian J. Harris, Summit Materials, Inc. - Executive VP & CFO [4]

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Thank you, Tom. Turning to Slide 8, I would like to start with the revenue bridge from 2017 to 2018. The majority of our revenue growth came from acquisitions in the West region, which accounted for $101.5 million; and in the East region, which accounted for $56.4 million.

Turning to Slide 9. You can see our adjusted EBITDA bridge for the full year 2017 to 2018.

Organic volume growth was impaired by adverse weather conditions throughout most of the year and was essentially flat in all lines of business except for Cement volumes, which were lower by 8.6%.

We were able to achieve selling price increases across all lines of business in the low to mid-single digit range, but unlike past years, we were not able to fully offset the impact of variable cost increases in the short term.

These cost increases came in the form of higher inflation in hydrocarbons, energy and labor and lost productivity due to weather delays.

The construction services business was negatively impacted by higher liquid asphalt input costs and several low margin or poorly executed jobs.

Adjusted EBITDA from the 13 acquisitions completed added $28 million in 2018, and given the timing of the deals, we expect limited carryover into 2019.

Turning to Slide 10. Here we show the key GAAP financial metrics. Operating income declined in Q4 and the full year as a result of increased costs in both products and services, which led to lower margins.

Depreciation, depletion and amortization expense was also higher by $25.4 million, reflecting the increases in capital expenditures and acquisitions over the past 2 years.

SG&A costs increased by 4.5%, reflecting a slightly higher pace of inflation and acquisitions.

Lastly, net income in Q4 and the full year reflects nonrecurring tax adjustments related to the impact of Tax Reform on our tax receivable agreement made in Q4 of 2017 and further adjustments made in Q4 2018, reflecting the latest pronouncements from the IRS related to the Tax Cuts and Jobs Act.

The one-off gain on sale of the PVC pipe business and higher interest expense also impacted the 2018 results.

Turning to Slide 11. You will see that our adjusted cash gross profit margin for the year declined by 440 basis points to 32.7%, and our adjusted EBITDA margin declined by 360 basis points to 21.3%.

The margin trends established during the first 3 quarters of the year largely continued in Q4, however, we were encouraged by the aggregates volume growth in Q4 of 10.3% and the aggregates average selling price increase of 7.6%.

Cement volumes were down in Q4 by 10% and gross margin, which until September had held up well due to excellent productivity, was negatively impacted due to reduced production volumes as we rebalanced inventory before year-end.

Turning to Slide 12. You will notice that average selling prices were up in all lines of business year-over-year. At 3.3% for the year, the organic aggregates price increase ended broadly in line with historic long-term trends. However, the price increase experienced in Q4 was stronger than we have seen for some time, reflecting a favorable product mix in the period.

As we've discussed on prior calls, our realized Cement price increase of just 0.6% was disappointing against the backdrop of stable end markets and tightening supply.

It is encouraging to see that the industry has announced much higher price increases for 2019.

Prices in our ready-mix and asphalt product lines were higher by 2.1% and 2.5%, respectively, but this was insufficient to fully offset variable cost increases and resulted in margin compression.

Acquisitions during 2018 were primarily in the aggregates and ready-mix space and drove the increased reported volumes.

For quarterly modeling purposes in 2019, SG&A should be in a range of $65 million to $68 million, DDNA should be a range of $48 million to $50 million and interest expense should be in a range of $28 million to $30 million.

We anticipate paying minimal state and local cash taxes and no U.S. federal income taxes.

Finally, with regard to total equity interest outstanding, as of December 29, we had a weighted average of 111.4 million Class A shares outstanding and 3.5 million LP Units held by investors, resulting in total equity interests outstanding of 114.9 million, and this is the share count that should be used in calculating the adjusted diluted earnings per share.

And with that, I'll turn the call back to Tom for his closing remarks.

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [5]

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Thanks, Brian. Turning to Slide 14 and 15. Our adjusted EBITDA guidance for 2019 is $430 million to $470 million, with capital expenditures expected to range between $160 million to $175 million, represented a decline versus 2018 of nearly 25% at the midpoint.

Based on this guidance, and without including any 2019 acquisition spend, we anticipate year-end 2019 net leverage to be below 4x adjusted EBITDA.

While we continue to opportunistically seek acquisitions, we anticipate a reduction in total spend in 2019.

During 2017 and 2018, Summit's capital allocation shifted towards organic capital investment, resulting in elevated expenditures as a percentage of net revenue.

In 2019, we expect capital expenditures to return to a more normal 7% to 8% of net revenue.

Turning to Slide 16. Looking ahead to 2019, we are optimistic about returning to growth and better margins throughout our business. The price increases announced in all lines of business are anticipated to at least offset expected cost increases, which will result in improved margins.

We have invested in several significant organic capital projects over the last 2 years that will improve productivity and drive cost reductions, particularly in our aggregates line of business.

We remain optimistic on the construction cycle and demand outlook and expect that our initiatives, coupled with improved weather relative to the extreme patterns experienced in 2018, will result in a meaningful return to organic growth.

I want to especially thank all of our employees for their dedication and commitment to Summit throughout what has been a very challenging year.

We will continue to focus on providing a safe work environment, and we are committed to generating value for our shareholders.

With that, I'd like it -- to turn it over to the operator for questions. Operator?

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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 Rohit Seth with SunTrust.

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Rohit Seth, SunTrust Robinson Humphrey, Inc., Research Division - Associate [2]

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Can you just maybe walk us through what scenarios would get us to the low end into the high end of the guidance range?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [3]

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Yes, Rohit. I mean, really, the biggest variable's going to be weather. We are very optimistic on price and cost, really whether -- the midpoint of the range assumes more normal weather. If we get better weather, we should get up towards the higher end. And if we have a repeat or a near repeat of last year, it will be at the lower end. So it's really -- we widened the range due to our uncertainty on the weather that came out of 2018, so it's really more weather related as far as widening the range.

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Rohit Seth, SunTrust Robinson Humphrey, Inc., Research Division - Associate [4]

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Got you. So is there anything you're seeing on the ground in terms of new projects coming to the market in maybe some of your key states?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [5]

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The area where we participate in large projects, I guess there'd be 2 of them, 1 is up in Vancouver and there's a couple of very significant large projects up there that we are optimistic getting at least a part of them. And in Texas, the Grand Parkway is going in Houston, we should sell some aggregates to that project, but probably more importantly for us in the Houston area is our competitors really are very active in those large projects, and if they're busy, that's good for us. But in general, Rohit, we don't really participate or really want to participate in the larger projects. That tends to make for more lumpy results, and they tend to be lower price and higher risk. So we focus on the more mundane, smaller projects, which we think are better for our business.

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Rohit Seth, SunTrust Robinson Humphrey, Inc., Research Division - Associate [6]

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Got you, okay. And then final question, clearly, challenging on costs, I mean is there -- what incremental should we expect in your aggregates, cement and concrete businesses going forward?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [7]

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Brian?

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Brian J. Harris, Summit Materials, Inc. - Executive VP & CFO [8]

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Yes, it has been challenging year, Rohit, on costs across the board. Weather has obviously had a lot to do with that and as we've mentioned on prior calls, we saw those inflationary price increases early in the year, which really continued into Q4. When we were on the Q3 call at the beginning of November there, we already knew that October was a bad weather month that continued into November, so we saw basically a continuation there. We do expect though, kind of a return to the sort of margins that we'd seen in 2017, where we ended 2017 on aggregates in the mid-60s. We're at a little bit below 60% this year. So with a combination of improved productivity; a relatively more muted inflationary environment, we think; and obviously, we've hedged quite a portion of our input diesel costs for next year; together with price increases, we would expect to return back to more like a full year in the mid-60s.

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Operator [9]

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

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Trey Grooms, Stephens Inc., Research Division - MD [10]

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First one is on -- just on the aggregates pricing. Pretty strong pricing in the quarter. Anything unique going on there that would drive that? Anything to note there in the quarter? And kind of expectations looking into '19?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [11]

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Yes, Trey. The Q4 was really a mix issue, really if you look at it, mix adjusted, it's in line with the annual, about 3.5%, so it really was a mix issue which helped Q4. But going into 2019, we have been much more aggressive in our price announcements in the mid-to-high single digits and are very optimistic about our pricing and aggs for 2019, and we should do better than our 2018 number of about 3.5% mix adjusted price.

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Trey Grooms, Stephens Inc., Research Division - MD [12]

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Okay. And just to be clear, mix adjusted, is that a geographic mix that was impacting or more product mix?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [13]

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Just product mix, Trey.

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Trey Grooms, Stephens Inc., Research Division - MD [14]

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Okay, got it. That's helpful. And then looking at the guidance for '19, I know -- kind of looking in the rearview mirror, '18 was kind of unique, the cadence wasn't maybe normal as what you would normally expect, so how should we be thinking about cadence as we look into '19 from a -- kind of a quarterly standpoint? Seasonal standpoint? Anything unique that you guys are expecting from a cost standpoint or core volume that we need to be aware of?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [15]

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Nothing jumps out, Trey. I mean, what I can say about 2018 was we had 4 bad quarters, and the comps should be relatively easy consistently through the year. As always, I would say 2018 was the first year that I have seen weather materially impact the overall -- the full year. It always moves stuff between quarters, and that's hard to predict. I mean, you get a wet spring normally, you have a drier summer, drier fall, and I'm sure that will happen again. But I don't know. Brian, I don't think there's really much to say on the cadence.

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Brian J. Harris, Summit Materials, Inc. - Executive VP & CFO [16]

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I don't think so. It'll be the typical -- Q1's always our lowest quarter. We ramp up through the spring. Q2, Q3s be our biggest, and then Q4 starts to wind down again as we get towards the winter, and that's really just the cadence. We don't expect anything significantly different from that in terms of the quarterly pattern of business.

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Trey Grooms, Stephens Inc., Research Division - MD [17]

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Okay. And then if I could sneak one more in. You talked about proactive cost control as well as focus on execution excellence. I think it was what you had in the slide deck. What are you guys -- can you talk about what you're doing differently there as we kind of look out? You mentioned you're not expecting quite as much on the inflation side maybe this year, but outside of that, more along the lines of self-help-type of activities and any color you can give us there?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [18]

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Well, we have a couple of big projects that are coming, that have come on stream recently, our Cement terminal in Memphis. We built a very large and very fine crushing plant at our Cox quarry just outside of Vancouver. Those will both make significant contributions this year, and there was a number of other smaller projects that also should have some contribution this year. We had a few larger projects that we probably shouldn't have participated in, in the West that we did not do very well on. We are not going to participate in those types of projects again in 2019, and we have reduced headcount where appropriate across the group. So we come into 2019 a bit leaner, a bit more focused on sticking to our knitting, and we see significant cost improvements in our business, especially I would say in aggregates. And then on the Cement side, we produced at a world-class level over the last several years, and we see that continuing into 2019.

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Operator [19]

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Our next question come from the line of Kathryn Thompson with Thompson Research group.

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO and Director of Research [20]

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First focusing on the Cement segment. How much of Cement volumes were impacted by weather versus competitive dynamics in the quarter? And given some of the adverse weather we saw in the quarter, could you give some color where we stand currently with clinker inventory? And how that may or may not impact early 2019?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [21]

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Yes, Kathryn, just a -- an estimate would be of the volume decline in Q4, probably half of it was competitive pressure and half would've been weather. Our clinker inventories are fine, and we don't see any impact on Q1 results as far as that goes. And did I miss another part of the question?

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Kathryn Ingram Thompson, Thompson Research Group, LLC - Founding Partner, CEO and Director of Research [22]

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Really, if the clinker inventories are fine, it shouldn't impact your first half. That's really kind of really the main driver with the clinker inventory?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [23]

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Yes, we reduced production in Q4 and dialed it back a bit to make sure that we wouldn't have an issue in Q1.

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Kevin Lee Money, Cleveland Research Company - Senior Research Analyst [24]

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Okay. And following up on just some of the inflation question, could you remind where you are hedged for energy going into 2019? And how we should think about the residual impact of margins as we go into '19 in light of your guidance?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [25]

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Brian?

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Brian J. Harris, Summit Materials, Inc. - Executive VP & CFO [26]

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Yes, so for diesel hedging, we've got about 70-plus percent of our 2019 estimated usage already pre-purchased, brought forward. It's at a rate that is close to the rate that we ended up with in 2018, so we don't expect diesel in 2019 to be a headwind, but it was in -- going from '17 to '18. That's the main hedging that we do.

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Operator [27]

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Our next question comes from the line of Stanley Elliott with Stifel.

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Stanley Stoker Elliott, Stifel, Nicolaus & Company, Incorporated, Research Division - VP & Analyst [28]

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Could you all talk a little bit about the Cement pricing? The confidence that you're having, on the front page [of the lease], you talked about low single-digit historical pricing. And then obviously, this -- the -- kind of the 8-ish dollar, it would imply something greater than that and then we still have the competitive pressures. Just try to help us sort of -- could you help us kind of sort all -- sort through all of that, if you could, please?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [29]

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Yes, in our direct market, we came out with a $10 per ton price increase effective April 1. Others in that direct market came out with $8 a ton, and then there are some -- a couple of players who came out with $6 a ton in contiguous markets. So you could look at a probable $6 to $8 ton announcement. So far, things have been going well with our customers, and I think what I said in the opening was that, look, our customers are experiencing inflation and I think that we expect, with a more inflationary environment being able to realize a significant -- a significantly higher level of price. Competitive pressures, I can't predict, we haven't seen any in 2019 so far, but we're optimistic that those should mitigate or go away in 2019.

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Stanley Stoker Elliott, Stifel, Nicolaus & Company, Incorporated, Research Division - VP & Analyst [30]

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And then thinking about the public funding side, right? I mean, obviously, the Texas market looks pretty good, probably Utah as well. What about -- Kansas and Kentucky have really kind of lagged a little bit on the public piece. Has there been much in the way of changes there when we're thinking about how the year unfolds?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [31]

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Well, the new Governor in Kansas has reduced the raids on the Highway Trust Fund for about $100 million of this year, and so that should get a little bit better in Kansas. If -- Kentucky will probably stay stable. There's a lot of conversation in Kansas and Kentucky and Missouri. Missouri, we -- a valid initiative was defeated to increase highway spending significantly, but all 3 of those states, there's a lot of conversation going on about significant increases in highway spending, and I don't think they'll impact 2019, but I think as going forward after 2019, we should see some increases in those 3 areas. The other thing I would say on highway spending, Stanley, is that the -- our East operations in the Carolinas and in Virginia and in Georgia, we should see significant highway spending increases in those markets.

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Operator [32]

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Our next question comes from the line of Jerry Revich with Golden -- Goldman Sachs.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [33]

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I'm wondering if you folks can talk about the magnitude of price increase announcement that you're implementing for aggregates, asphalt and concrete. So what have you communicated to customers as we get ready to enter the construction season in a month or 2 here?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [34]

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Yes. In aggs, as I said earlier, we're in the mid-to-high single digits that we've announced in our local markets. We're getting good reception on it, and we would hope to have realized a significant amount of that. On ready-mix, our 2 big markets, which are the Intermountain West and Houston, which account for well over 50% of our ready-mix lines, we're out with high single digit price increases there, and we're, again, optimistic about realizing a fairly high percentage of that. On asphalt, price is really not very meaningful just because of the different grades of liquid asphalt that we use, which really make price not a very good metric to focus on. But because of the decline in oil prices, decline in liquid asphalt, decline in the fuel oil and natural gas that we use to power asphalt plants, we are pretty optimistic on margin overall in asphalt.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [35]

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And Tom, can you expand on that last point? So year-over-year margin expansion in asphalt and the other businesses, when do you expect to get there based on pricing? Do you expect to get there in the first quarter? Or do we have to wait until we're in the construction season before we're back to expanding cash gross margins year-over-year?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [36]

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Yes, it's really -- the first quarter's really insignificant in asphalt, just because you really need to be 45 degrees and rising in order to put asphalt down. So it's really, it's not getting -- third quarter's would be the big -- even the October and November can be big in asphalt, but really the first quarter's pretty insignificant.

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Jerry David Revich, Goldman Sachs Group Inc., Research Division - VP [37]

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Okay. And then in terms of the visibility on volume cadence over '19, can you just expand more on what gives you confidence on the visibility that we can grow off of the weather impact on volumes in '18? When we look at some of the public comments from the homebuilders, there's certainly an air pocket in that end market. Private non-res is at a healthy level, but slowing, so I appreciate that weather was a headwind in '18, but maybe you could share some of the data points that give you comfort that we're going through rebound off of that level, given the air pockets and even potential slowing for some states that have a high reliance on federal funding for their DOTs?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [38]

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When you look at our individual markets, in Vancouver, just starting from the West and going East. Vancouver, we're optimistic about volume there, there's some big projects out in the market, our volumes have been pretty strong there, we have a new plant, a significantly new plant with additional capacity, so we're pretty optimistic there. If you go to the Intermountain West, I would say one of the constraints there will be just labor force of -- on our customers. Demand for housing, especially entry-level and pretty much across the Intermountain market, is quite strong, so it's really how much the builders can actually get done. So I think that takes places like Utah and Nevada from being high growth to low growth because of the constraint on labor, but certainly we're going to see some growth there. The highway markets are very strong. In those markets, we have a really nice business on the Western Slope of Colorado. Colorado's highway program is quite good. So we're -- we feel good about that. And then Texas, we've already said. I -- in Houston, where we're probably heavily exposed to residential, it has been so wet there that it is really hard to judge what the underlying demand is, and it's tough to tell, but our customers are very optimistic. When the sun shines there, we're really busy, and I would say that I think we should have a good year there. The Midwest, our Kentucky, Kansas, Missouri, as I mentioned earlier, highways are pretty stable, low growth. And overall in those markets, we see pretty stable, low growth markets across the board in all 3 end uses. Then the East is sort of the opposite. We're pretty much strong in all 3 end uses there. And a couple of things, on non-res, for us, Jerry, we really do sort of the low rise strip malls that follow residential development, and we don't really do some of the larger, more cyclical office and high-rise, and I think that's a positive. But we have not seen, in our market, the air pockets on residential. We just haven't seen that yet in our markets. And I don't know if that's because we're more mid-cycle than most of our markets, but we just haven't seen it.

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Operator [39]

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Our next question come from the line of Garik Shmois with Longbow Research.

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Jeffrey Stevenson, Longbow Research LLC - Research Analyst [40]

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This is Jeff Stevenson on for Garik. And I just had a question, when you look at kind of the midpoint of your guidance, can you give a little more color on kind of what you're expecting from organic earnings growth versus kind of nonrecurring cost you've baked into the guidance?

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Brian J. Harris, Summit Materials, Inc. - Executive VP & CFO [41]

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The bulk of the growth next year, Jeff, is going to be organic, so we've kind of baked in a -- something of a normalization of weather. As Tom mentioned, we've baked in certain level of price increases to offset inflationary costs. And as you know, our guidance does not include acquisitions. The only carryforward amount that we've got for deals completed in 2018 would be $2 million. You can see that in the reconciliation on exhibit 8 of the presentation. So really all of our growth next year is organic.

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Jeffrey Stevenson, Longbow Research LLC - Research Analyst [42]

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Okay, great. And one theme from last year was logistics and freight bottlenecks. I'm just wondering what you're seeing on the ground this year, is there any alleviation from that and any expectations into '19?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [43]

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We're a little different than some of the other companies in the sector. We don't do much by rail or by barge. We do ship cement by barge, and we didn't really have any constraints or logistical issues last year. I think as all industries right now, there is a shortage of truck drivers, but we just haven't really seen that constraint in our businesses. It's a struggle getting truck drivers, but we have managed to do that in 2018, and we're optimistic in 2019. So we just -- we don't see the logistics as a major bottleneck in our business.

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Operator [44]

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Our next question comes from the line of Phil Ng with Jefferies.

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Collin Andrew Verron, Jefferies LLC, Research Division - Equity Associate [45]

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This is actually Collin on for Phil. In the aggregates business, it looks like the margin headwind accelerated in the fourth quarter, just given the year-over-year declines. Could you give us some more color and possibly quantify the different margin headwinds within the aggregates business specifically? And then how quickly do you expect people to recover margins in that segment? And is -- should there be any overhang as you enter into 2019 in the beginning of the year?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [46]

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I mean, I -- one of the biggest issues for us in Q4 on aggregate margins was cost. And most of those were weather related. It's -- between very wet Texas and very cold early winter in the -- pretty much throughout the Midwest, that, that really had a pretty significant impact on our cost. We hope to see those reverse very quickly in 2019.

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Collin Andrew Verron, Jefferies LLC, Research Division - Equity Associate [47]

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Okay, great. And then just given the government shutdown, have you guys seen any impact on public construction going into the construction season?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [48]

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No. Haven't seen any, the lettings have continued as expected.

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Operator [49]

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Our next question comes from the line of Adam Thalhimer with Thompson Davis.

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Adam Robert Thalhimer, Thompson, Davis & Company, Inc., Research Division - Director of Research [50]

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Can you give some thoughts on M&A? And should we keep modeling $2 million a quarter in transaction costs?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [51]

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Our pipeline is certainly lower, at a lower level this year than it was a year ago. It's still active and there's still -- we're still busy looking at things, but it certainly has slowed. We will do some M&A. I think probably $2 million a quarter is probably high now, not sure that we'd give exact guidance, but I think you can probably take that down.

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Adam Robert Thalhimer, Thompson, Davis & Company, Inc., Research Division - Director of Research [52]

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Perfect. And then Tom, can you just comment -- I mean there's, obviously a little bit more optimism about a highway built this year. What are your thoughts there?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [53]

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I hate to say it, but not optimistic. I don't think we'll get an infrastructure package out of D.C., but the flip side of that is I see the states really stepping up, and I'm very optimistic about our overall highway end use being low to mid-single-digit volume growth. And in certain markets like Texas -- I mean, Texas is just absolutely flying, and so I see we've had steady increases in highway funds out of the federal government. I see that continuing. There's certainly -- but I just think it's going to be difficult to get a large infrastructure package out. I think you'll see some steady increases in the federal spend, and I think you'll see some good, really solid, larger increases out of the states. We've had pretty tough highway markets in Kansas, Missouri and Kentucky. When I look out over the next couple of years, I would see all 3 of those having really sizable increases and spend on highways.

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Operator [54]

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Our next question comes from the line of Scott Schrier with Citi.

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Scott Evan Schrier, Citigroup Inc, Research Division - Senior Associate [55]

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I wanted to talk a little bit about ready-mix or downstream. In ready-mix, little bit of a price decline, you talked earlier on the call about some issues in services, so I'm wondering if you could talk a little bit about specifically, where you might've seen some more competition in the ready-mix side. And then generally speaking, if I think about the downstream markets being more competitive, which is difficult in a rising cost environment, does it change how you think about allocating your capital, whether internally or inorganically, to upstream businesses? Or conversely do you look and say, "Hey, we need to consolidate some of these markets more in the downstream?"

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [56]

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Yes, I mean I would say that one of the biggest impacts in our downstream in 2018 was weather and also hydrocarbons. You use a lot of hydrocarbons in both the ready-mix and in the asphalt business. And I think that those 2 should certainly -- those 2 impacts should decrease significantly in 2019. I have always been a great believer in the vertically integrated model, and I think if you have strong positions in aggregates, that you can take some of that benefit into the downstream. And markets vary. We haven't seen a whole bunch of entry on the ready-mix side, a little bit in Houston. We've had onesie-twosies, but it -- the decline in margins hasn't necessarily been a result of increased competition, it's been more a fact of really poor weather impacting the overall business, and if there's -- it's -- you lose -- the problem with weather is it impacts price, volume and cost. So I see our downstream businesses improving rapidly in 2019 as the impact of energy increases, ameliorates in the fact that weather should certainly improve. So I don't know if that answered your question, Scott.

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Scott Evan Schrier, Citigroup Inc, Research Division - Senior Associate [57]

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Yes, Tom, that's helpful. And then I just wanted to ask about a couple more, the comments you said on the call. So Brian, I believe earlier you said you would expect to get back to the mid-60s in aggregates. And quick math says that looks to be close to 90% on incrementals, which you've done in the past and it seems doable, if, in fact, you do get that mid-single-digit to high single-digit agg pricing that you said earlier that you have out there in the markets. So -- and I understand you have these other cost initiatives to take out some costs, so I just wanted to get some conviction around those numbers. It seems like, from your comments, you have a lot of conviction in that mid-single digits or even better in aggregates, if possible, and 90% incrementals in aggregates is possible, and that we're going to get that, and that generally takes us to the midpoint of the guidance. Is that the correct way to think about the summation of all these comments?

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Brian J. Harris, Summit Materials, Inc. - Executive VP & CFO [58]

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Yes, that's right, Scott. As you rightly point out, we've been at those levels historically. I know if you go back to 2017, certainly, we were hitting those kinds of numbers fairly regularly, when we got to the peak of our season. When we have good volumes and those kinds of price increases then yes, that's the sort of incremental margins that we can expect. So that's really how we've -- what we've baked into our expectations for 2019.

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Scott Evan Schrier, Citigroup Inc, Research Division - Senior Associate [59]

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Got it. And one last one on cash flow, and I know in the press release you mentioned you expect higher free cash flow, and I know some of that will just be on the lower CapEx. I'm just curious if you could speak to what we're seeing maybe in terms of working capital, and maybe how you think about what an acceptable free cash flow conversion rate would be in '19?

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Brian J. Harris, Summit Materials, Inc. - Executive VP & CFO [60]

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Yes. Working capital tends to be very stable, around about the 12% to 13% range. It obviously moves around a little bit from a dollar perspective as we ramp-up at the beginning of the season with inventory levels, and then comes back down again towards the end of the year as we begin to wind things down. That's just part of the normal cadence of the business, but it doesn't typically fluctuate significantly. You're absolutely right about the free cash flow, we'll be higher in 2019 as a result of the lower CapEx that we've guided to. And other than that, there really aren't any other major moving parts. We typically would expect to get a cash conversion rate probably round about a 70%.

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Operator [61]

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Our next question comes from the line of Brent Thielman with D.A. Davidson.

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Brent Edward Thielman, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [62]

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Tom, just was reading through the release, there was -- it seemed like there's a pretty big difference in results in asphalt between the 2 regions. Just noticed pricing in the West looked like it was sort of effectively flat and the East was up 17%. Is it -- is there any readthrough there? Is it just state of the markets? Or competitive dynamics? Or just an anomaly?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [63]

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Yes, again, price is pretty meaningless as a metric in asphalt just because of the variation in liquid asphalt input cost. We certainly have seen competitive markets in the West, and we also had some execution issues in our Western region on the asphalt side. So we hope that both of those will improve in 2019. So there is a market difference, but really, price -- just really have to look at margin.

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Brent Edward Thielman, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [64]

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Okay. And it -- I mean, it sounds like most of the markets you're in look pretty good here into 2019. Are there any areas within the portfolio that you're concerned about that maybe think are peakish?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [65]

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I would worry about labor constraints in Utah. I -- the rest of the markets, I mean, our Eastern markets are quite strong. I think the central is going to stay stable as it has been for the last couple of years. Austin, where we have a pretty small business these days, is -- the market's quite strong, but it's still very competitive. And our North and West Texas are strong, both in highways and then the private side res and non-res in Odessa/Midland is, like I say, is very strong. So I really don't see a whole lot. We just -- it really hasn't changed much from our Q3 call.

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Operator [66]

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Our next question come from the line of Nishu Sood with Deutsche Bank.

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Timothy Ian Daley, Deutsche Bank AG, Research Division - Research Associate [67]

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This is actually Tim Daley on for Nishu. So my first one is on your leverage. So obviously, you guided to the sub-4x leverage target by year-end. But just given the more conservative acquisition strategy, how are you guys thinking about a change -- potential change in capital allocation once you do hit that target?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [68]

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We see -- we're still in the acquisition business. It's been a little bit more competitive than last year, and now the deal flow has slowed a bit, so naturally, even outside of leverage, our acquisition spend was going to decline anyhow. We see it being back in the acquisition business and being very careful for making sure that we have good deals and we see being in the acquisition business and also being able to slowly delever over time. So it's really just a continuation of our existing strategy.

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Timothy Ian Daley, Deutsche Bank AG, Research Division - Research Associate [69]

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Got it. Appreciate that color. And then my second question is, so Cement fourth quarter saw some -- being plagued by some of the same issues that drove softness in past performance. One of those issues I know I guess was the market susceptibility to imports. Or I guess the kind of current versus historical and potential changing in import volumes. So a couple of days ago, obviously there was Trump's Buy America mandate was rolled out to infrastructure projects. Just curious, kind of high level thoughts, but anything that could potentially change there in regard to import/export dynamics and cement pricing in the market in general?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [70]

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Yes, the -- imports have had little-to-no impact on our markets. In fact, we have an import terminal in Baton Rouge where we would hope to import product as demand increases. I am not actually sure what was in Trump's infrastructure import bill as far as whether it affected cement or not.

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Karl H. Watson, Summit Materials, Inc. - Executive VP & COO [71]

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It did put us on -- and even China -- and it was 10%. It was going to go up even further in January, but that got delayed, but there's currently a 10% import tariff in cement coming in through the West Coast of China.

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [72]

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Which won't have any impact on our business. And that was Karl, by the way, commenting on the cement imports. So I -- certainly, in our market, it has little-to-no impact.

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Operator [73]

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

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Michael Benjamin Eisen, RBC Capital Markets, LLC, Research Division - Senior Associate [74]

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Actually, Mike Eisen on the line from RBC. Two quick follow-up questions from me. First, starting off on the cement business. When you highlighted some of other price increases from the market by competition, very helpful to know. Are there any competitors that have not gone forward with price increasing? And do you expect all to in the market?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [75]

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No, everybody's -- everybody's announced at this point.

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Michael Glaser Dahl, RBC Capital Markets, LLC, Research Division - Analyst [76]

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Awesome. Very helpful. And then one last follow-up. From a high level perspective, you've talked about your private commercial side of the business lagging residential. We've definitely seen some slowdown in order trends across the country, so I just wanted to know have you seen any exchange in conversation about projects in the pipeline with those customers, and how they're thinking about future growth? And the outlook for following the residential market?

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [77]

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Not really. I mean we -- we're -- we especially participate in those markets in Houston and in Salt Lake, the -- our order books are solid, and we haven't seen any slowdown or conversations of slowdown with our customers.

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Operator [78]

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(Operator Instructions) There are no further questions at this time, and I would like to turn the call back to Tom Hill for closing remarks.

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Thomas W. Hill, Summit Materials, Inc. - Founder, President, CEO & Director [79]

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Thank you, operator, and thanks, everybody, for joining us. That concludes our call.

Have a good day.

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Operator [80]

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This concludes today's conference. You may disconnect your lines at this time.

Thank you for your participation.