Q3 2020 Builders FirstSource Inc Earnings Call

Good day and welcome to the builders Firstsource third quarter 2020 conference call. At this time all participants are in listen only mode. Following the Companys remarks, we will conduct a question and answer session. Today's call is being recorded and will be available at www Dot E.L.D.R. Dot com.

No my pleasure to introduce Mr. Bennett shouldn't be.

Vice President Investor Relations. Please go ahead.

Thank you Stephanie good morning, and welcome to the builders Firstsource third quarter 2020 earnings Conference call.

With me on the call today are Chad Pro Chief Executive Officer, Peter Jackson, Chief Financial Officer copy of the slide presentation reference on this call is available on the Investor Relations section of the build his first sight website at deal the our dotcom before we begin let me note that during the course of this conference call. We may make statements concerning the companys.

Get your prospects financial results.

The strategies and industry trends.

Such statements are considered forward looking statements under the private Securities Litigation Reform Act of 90, 95 and are subject to certain risks and uncertainties, which could cause actual results to differ materially from expectations. Please refer to our most recent form 10-K filed with the Securities and Exchange Commission and other reports filed with the FCC for more information.

And on those risks.

The company undertakes no obligation to publicly update or revise any forward looking statements.

Many will discuss adjusted results on this call. We have provided reconciliations of non-GAAP financial measures to their GAAP equivalents in our earnings press release and detailed explanation of non-GAAP financial measures in our form 8-K filed yesterday.

Both of which are available on our web site.

I will now turn the call over to Jeff.

Thank you Ben.

Good morning, and thank you for joining us on our third quarter earnings call.

That's the pandemic continues.

Hope you and your families are staying safe and healthy.

I saw it continue to be with those affected.

And I would like to again recognize our dedicated team members for their commitment to excellence.

During the challenges of the past several years.

The safety of our team members and of the surrounding communities, where we operate.

Remain our top priority safety will continue to guide our operating strategy.

Before diving into our results.

I will start on slide three and spend a moment discussing our recently announced merger with BMC stock Holdings.

This merger is on track to drink the nation's premier supplier and building materials and services with combined adjusted EBITDA of approximately $950 million, including run rate synergies.

Together, we will have an expansive geographic footprint and enhance local relationships in attractive high growth markets.

The combined company will benefit from greater geographic reach and diversity within what is still a very fragmented industry.

We will have a strong footprint in many of the nation's largest and fastest growing regions and will be exceptionally well positioned for long term growth supported by a resilient housing environment.

We expect to continue to deliver above market growth through our shared commitment to value added product offerings, which allow us to close we partner with customers to streamline the construction process.

In addition, a larger platform will strengthen our ability to invest in best in class innovative solutions that deliver significant benefits to our customers.

During the past month, and a half day slipping in and I have traveled to many regions of the country, including Texas, The mid Atlantic the Southeast and Mountain States and the West coast among others and many of these cities. We have held town hall meetings to hear directly from our team members about their local market strengths.

It was extremely beneficial to observe both of our companies capabilities in real time and invest in all the ways, we will be able to complement each other to do some truly exceptional things for our customers.

It brought both of US grain prices are hard working team members across the country Theres efforts are directly responsible for putting us in a successful position we're in today.

Well, David I enjoyed getting to interact with so many team members and seeing their excitement for future opportunities as we take our combined business to new Heights [laughter].

In terms of timing, thus far the deal is progressing as expected.

The merger planning work is happening in the background right now continues to be very positive.

In October we filed a 30 day extension under the HSR review process with the deal Jay.

Also in October we filed our form S four with the SEC.

We are working diligently with those agencies.

Once we have completed these two regulatory milestones there will be a require 20 working day notice.

Before builders Firstsource and BMC request their respective shareholder approvals.

This keeps us on track to close the merger in late 2020 or early in 2021.

At this point I could not be more pleased with our significant strides towards winning together is one which is our merger tagline, while continuing to stay focused on customers and delivering exceptional operational performance.

Moving to our results on slide four I'll outline the key factors underpinning our excitement about what we've accomplished during the quarter.

First the momentum we carried into the third quarter continued with performance ultimately being better than we had anticipated.

The homebuilding markets have been resilient improve.

Improving housing starts record low mortgage rates and a shift towards suburban living were all positive fundamentals that continue to support demand for our products and services.

Since mid year activity in our end markets continued to trend positively, resulting in demand improving throughout the quarter.

During the quarter, we experienced a steady recovery in sales as we have seen broad based improvement across geographies and end markets.

We are back to work and all of our locations around the country and are able to safely and effectively deliver critical products and services to customers, while keeping up with the broker robust demand and much of the country.

Our team delivered strong results all around for the first nine months of the year sales increased by over 9% to a record 6 billion.

Approximately 3% of growth was from core organic performance.

And our five tuck in acquisitions completed over the past year added more than two percentage points to growth.

Housing demand has accelerated rapidly we have also seen commodity prices reached record heights.

Commodity inflation contributed approximately 3% of sales at one additional selling day contributed about 1%, which led to the increase in reported net sales of over 9% year to date.

This brings us to our second theme.

Our focused execution, we remained appropriately resource to capture rising demand in a disciplined manner. This is produced record adjusted EBITDA of $443 million for the first nine months of 2020.

Gross margin just shy of 26% year to date is a direct result of our ability to react quickly and effectively to rapidly evolving market dynamics since mid year.

In addition, our operational excellence initiatives remain core to our strategy.

Alongside the momentum in our markets are and our business right. Now this set of best practices is being implemented throughout the organization and making our company more agile and easier to do business with.

Key initiatives and process include investments in distribution and logistics software pricing and margin management tools back office process efficiencies and information system enhancements.

We launched these initiatives in 2018 and have made significant progress laying the groundwork for what we for what will no doubt prove to be efficiency enhancing investments as we move into our next generation of growth.

And finally amongst the many [noise].

Merger with Vmc to our team members customers and shareholders. We will continue to expand our network of value added offsite component manufacturing facilities, which are core to our collective strategy.

Post combination that will continue to be a focus of our combined growth with a portion of the cash we intend to generate we will continue investing in value added growth through both organic and inorganic opportunities.

As an example in October we commissioned the state of the Art Greenfield Trust plant in Riverside, California, extending our industry, leading position to 66 manufacturing facilities.

It is through new facilities, New trust lines in existing plants door facility expansions or other system enhancements.

These differentiated offerings offer industry, leading value add capacity.

And we will remain key to enhancing our geographic footprint technological capabilities and integrated partnerships with customers.

The favorable market conditions, we see today should provide growing opportunities for the bigger and better builders firstsource.

We know customers value our commitment to high quality service and in particular, our ability to continually invest in our service capabilities throughout the housing cycles. This is a differentiator for builders firstsource within our industry. It has been an elegant element of our success in 2020 and will continue to be a core focus after we complete our transformational Murray.

Merger with Vmc.

I will now call turn the call over to Peter who will review our third quarter results in more detail.

Thank you Chad good morning, everyone.

I like to start by also recognizing our teams focused execution, including the quick reaction to the sharp rise in both demand and lumber costs.

I will review our third quarter results provide an update on the merger and any guidance on how we see the market going forward.

We had $2.3 billion in net sales in the third quarter with core organic sales increasing 6.7%.

Organic excludes acquisitions in commodity impacts from net sales to give an indication of the underlying performance of the business.

We experienced accelerating demand demand across the country.

As demand continued to be stronger than expected throughout the home buying season.

Our five tuck in acquisitions completed over the past year added 2% to net sales commodity price inflation added another 7.2%.

As a result net sales total increased by 15.9%.

Our value added product categories continued to perform well within our respective markets.

I will note, however that the impacts of both commodity inflation and COVID-19, and the hardest hit regions of the country has had a disproportionate impact on our value added products, despite higher underlying demand in most of the country.

Gross margin of $570.7 million in the third quarter of 2020 increased by over 29, and a half million dollars over the third quarter of 2019.

Our gross margin percentage was 24.9%, which was well ahead of our expectations.

Go down 240 basis points from the third quarter of 29.

The margin percent decrease on a year over year basis.

A couple to sharp increases in commodity prices.

The commodity inflation lumber cost we have experienced since may continued throughout the quarter. So please keep in mind the mechanics of our margins as we have discussed on prior calls.

For the long term higher prices benefit our business, however, price fluctuations, especially when commodities can cost significant swings in our results.

Commodity cost inflation caused a short term gross margin percentage headwinds when prices spike relative to our short term pricing commitments that we provide customers.

Additionally, higher prices and commodity products have a negative mix impact on gross margin percentages.

As mentioned I am pleased with our teams ability to mitigate unfavorable impacts this quarter through a combination of focused execution and disciplined pricing.

As we near the ended the quarter commodity prices starting to ease, albeit at a very high level. Although we expect our gross margin percentage to continue to be pressured in the fourth quarter. We do expect to benefit from higher gross margin dollars generated from the higher commodity prices.

Interest expense increased by $300000 to $28 million compared to the same period last year.

Excluding the net impact of one time items related to debt issuance and extinguishments in the prior year period interest expense increased by $3.4 million due to higher outstanding balance as we proactively increased our liquidity and financial flexibility.

Third quarter, EBITDA increased $24 million from a year ago to 1180 $4.3 million an increase of 15%. This.

This is the highest quarterly EBITDA in our history.

And by the topline growth combined with the reduction in variable expenses related to commissions as well as lower travel in fuel costs.

EBITDA margin held steady at 8% compared to the prior year period.

Adjusted net income for the quarter was $96.7 million or 82 cents per diluted share compared to $84 million or 72 cents per diluted share in the third quarter of 2019.

The year over year increase of $12.7 million or 10 cents per share was primarily drove driven by improved operating results.

On slide six the.

The strength of our business was evident again in the third quarter.

Our team grew net sales across four or five product categories led by longer given the dramatic escalation in cost.

Value added core organic sales show healthy growth, increasing by approximately 2% despite continuing to be disproportionately impacted by geographies slower to recover from the pandemic largely in the northeast.

Excluding this region value added product sales grew by mid single digits in the rest of the nation.

With the continuing labor challenges faced by our customers demand for our labor saving products is expected to continue to rise.

To meet this growth we plan to invest approximately 25% of our total 2020 capital expenditures in our value added growth initiatives and expansion of our production capacity.

Core organic sales grew by an estimated 6% and our single family customer and market compared to the prior year.

Helped by accelerating demand in the majority of our regions.

Market Tailwinds and underlying economic conditions continue to be very supportive of demand build.

Builders are ramping up activity in response to that demand as evidenced by double digit year on year increases in single family starts.

We expect these starts to provide a long runway for growth as they translate into increasing units under construction and ultimately completions.

Core organic growth in the aren't our and other end market grew by 7% as we continued to see relative strength in the western part of the country.

Thanks Stanley core organic increased by 18% largely due to the timing of large projects.

Turning to our outlook on slide eight our results in the first nine months demonstrate a positive homebuilding environment that is supporting rising demand across our footprint, which continued into October.

Year to date results reflect our team's focus execution and ability to stay on top of the extremely dynamic commodities market from both the price and cost management perspective.

Our success is in large part attributable to our team's experience in managing through all types of market environments, and the trust customers, placing us to be their partner of choice.

During 2020, the housing market has proven to be resilient with annualized single family housing starts rising 17% in the third quarter and up 6% year to date.

A number of Tailwinds point to further strengthen the fourth quarter and beyond.

Builder confidence index reached an all time high of 85 in October we estimate significant pent up demand from increased household creation and significant undergoing a single family homes over the past decade more.

Mortgage applications continue to climb with mortgage rates also near all time lows and existing home inventories also near all time lows of three months supply.

We are seeing the benefit of residential construction catalysts in nearly all localities, where we operate outside of the northeast.

With this backdrop drop backdrop, we are introducing our outlook for the fourth quarter.

We estimate adjusted EBITDA to be in the range of 190 million to $210 million.

We anticipate fourth quarter core organic sales to be in the mid to high single digit percent range year over year.

While we are undoubtedly optimistic we continued to manage our business with a prudent growth, except assumption, which accounts for the lag before housing starts translate into units under construction and ultimately completions in.

In recent months factors, such as tight labor and material scarcity has extended builder construction cycles to put that in perspective overtime completions will approximate roughly 100% of stars, but at the moment completions represent only approximately 80% of the current level of housing starts.

Keep in mind, our core organic growth outlook reflects our core sales performance and excludes the sales contribution from acquisitions as well as the significant commodity inflation that we expect in the coming quarter.

We estimate our fourth quarter gross margin percentages to be consistent with Q3 at around 25%.

For the full year 2020, we continue to expect our cash interest to be in the.

$110 million to $115 million range.

With our growth projects underway again, we reiterate our expectation for capital expenditures to be in the $100 million to $110 million range for the full year.

Since 2018, we have generated nearly $1 billion of operating cash flow and we fully expect to build upon that cash generation through year end 2020.

I'll now turn the call back to chat for his closing remarks.

Thank you Peter.

This is an exciting time for builders firstsource.

We're on path to close out a record year with 2020, adjusted EBITDA is expected to be approximately $640 million.

Or 25% above last year at the midpoint of our guidance.

This outperformance to prior year comes as we reap the benefits of the structural enhancements, we have made as we implement operational excellence initiatives.

Deepen our presence in high performing value added businesses and empower our sales teams to compete wisely in the commodity product market.

I am incredibly proud of the builders firstsource team and thank each member for their dedication to our company customers and communities.

Looking ahead, we're all very pleased to welcome the BMC team to the builders Firstsource family are accomplished our accomplishments accomplishments to this point.

We have only strengthened my conviction in the merits of this merger.

Merger will allow us to deliver solutions that make our customers more productive and efficient.

Through deeper and more integrated relationships than ever before.

You added offerings, we will continue to represent the largest portion of our business and the focus of our investments with.

With our expanded capital resources, we believe we will be uniquely positioned to accelerate our profitable growth through underlying market expansion supplemented by targeted acquisitions and operational excellence initiatives.

This merger aligned with our share growth strategies and occurs at an optimal time for both companies to create significant value to a much larger and more efficient platform.

We look forward to completing this merger and working closely together with a unified leadership team that has a proven record of successful integrations. Thanks.

I'm confident that with the two outstanding organizations coming together, we will be better positioned than ever to be the supplier of choice for building materials and value added products and services in the years to come.

With that thank you again for joining us today, and we will now open the call up for your questions.

Thank you I'd like to ask a question. Please signal by pressing star one on your telephone keypad.

Are you seeing the speaker phone. Please make sure. Your mute function is turned on July you signal to recharge equipment begin press star one to ask a question.

Our first question comes from Matthew Bouley with Barclays.

Good morning. Thanks.

Thanks for taking the question about.

Congrats on the results.

So I wanted to start out maybe pressing on the value add products performance a little bit.

Organic is still a little lighter than the rest of the business and.

It sounded like you're attributing.

Disproportionate impacts from from the northeast and I think you said Peter mid single digit growth elsewhere, if I heard you right.

But I think last quarter, there was some underperformance, which you you talked about related more to the west into Florida. So I guess, if you could just kind of unpack sort of what's going on there and maybe how value add is expected to perform within that Q4 revenue outlook.

Sure yes so.

There are a couple of layers to this has been a pretty dynamic year. So as we talked about the beginnings of Cove its impact on our business the parts of the country, where we were hardest hit north.

Northwest, the northeast and Florida, where those areas for the most part that we're seeing government shutdowns right. So everything was shutdown or significant parts of the business were shutdown so low.

Lot of exposure to value added in those businesses. So we saw the.

Greater than normal or greater than average negative impacts on value add.

As we got into this summer and into the back half of the year the geography impact.

Still true from the perspective that I would say the northeast has been the slowest to recover the northwest to bounce back pretty quickly after the cobot reopening head.

The the entire northeast corridor has been much more.

I would say.

Gradual in the recovery back to normal I'd say still below normal in those markets and again that exposure in commodities.

And it is different im sorry, the exposure to value add.

Shoe is different in those markets than it is in the rest of the country.

Another way to look at is if you think about those parts of the country that have grown.

Most and have the best performance.

You think about the South Texas is a great example.

In many ways electing not to participate in the downturns related to Cove. It that's a market that doesn't have as much exposure to that value added products.

There are some other factors at play we talked a little bit about the extended build times we.

We think that the homebuilders cycle. Despite the rapid increase starts his extensive we've heard that comment from a few folks whether it be due to product availability or.

Labor availability, we think that is also showing a bit of an impact, particularly on products that we see towards the back half of the build cycle. That's included value add for us.

All in all we're we're not concerned about it we continue to monitor is important obviously to our strategic vision for the company but.

All of our data says we have reason to be confident we're positive about our backlogs we think that.

The overall environment is very very positive and we see it picking up again.

But certainly there have been some speed bumps, we all know how hard it is to run a manufacturing operation in general and during the Asian to cope with.

Thats right.

Certainly a challenge for us So we'll continue to keep an eye on it and manage it but certainly optimistic about what we see coming backlog look good demand looks good and see people moving away from manufactured product.

So we think it's just some.

Unevenness in the business.

Okay that makes sense I appreciate the thoughts there Peter.

And secondly, I wanted to ask just just on the.

On the merger.

Sounds like the timelines on track, but you've continued to obviously progressed with the merger planning. So I guess I'm. Just curious if there is any sort of operational updates around how you're thinking about that some of the things we talked about like overlapping locations in a few markets may be any finer points.

On the synergy potential just you know as you continue to dig deeper I'm just curious what kind of the latest is on the on the operations. Thank you.

Yeah, I would I would kind of sum it up as as expected.

Clearly, we're still two separate companies and so we are doing as much of the planning as we can.

In the interim.

You know as I mentioned in the prepared comments, Dave and I visited a lot of locations. There is a lot of excitement out there amongst our team members on the opportunities that we are going to have as we go forward company, but no real surprises good or bad so far it's just as expected which is good.

Still feel good about the synergy ranges we've given.

One thing that is clear we are all very busy.

So there's not a whole lot of excess capacity sitting around at the moment, which is a high class problem to have.

So yes, its its going as expected, which is which is a good thing.

Great. Thanks, Chad Thank you Peter.

Thank you Matt.

Thank you. Our next question comes from Mike Dahl with RBC capital markets.

Good morning, Thanks for taking my questions tremendous results as.

Hi, good way into next year.

First question just around margins and this is more thinking towards.

2021.

So.

As you noted lumber as.

Started to move lower and given your.

Your lag yet.

Would you think about 2021 as being.

Back in that normal 26% to 26.5%.

Percent range at this point and I guess similarly.

Any thoughts on there's there's always moving pieces around us gionee, but you guys have done a great job keeping costs under control and leveraging.

The topline so any thoughts on on kind of where we should be thinking on normal assuming that.

Yes, Thats a great question and.

You've heard me make this half joking comment before you can tell me what commodities are going to be I'll tell you what my margins are going to be.

It's it's a really big question Mark you know that that run up that we saw this year in commodities is unprecedented and wallets turned.

It's certainly not back to historical norms were quite elevated.

And I think the market in some ways to still digesting it certainly still passing through in our pricing.

Yes, we right some of the materials at the homebuilders have put out there about what they're doing with better pricing.

You know some people may be tried to play the game a little bit from what we're reading into their comments, they've tried to slow down or speed up their build cycles.

Personally I think theyre Miss out in terms of the opportunity and the demand that's out there we are motivated to build whatever we can and get it out and I think that that dynamic as it evolves over the next six months will be.

Impactful on us no doubt, but the core of the business is where were all of our effort is going in terms of being ready to deliver on that demand.

Good.

The the likelihood that we're going to see.

Were returned to those really high lumber prices is low so I think it's fair to say that we will see some tailwinds associated with deflation for a bit of time.

But it's so volatile and so dynamic different in different parts of the country that I'd say at this point I'm not comfortable putting that normal out there for you.

What what you are saying doesn't sound unreasonable, but I couldn't point you to a real number at this stage just until things normalize and sort of settle out a little bit the.

The other big factor is putting our two businesses together and seeing what are you know what the combined entities starts to perform at that will be a critical piece of that as well.

Yeah, I would just add nothing has structurally changed with our business, obviously, but it is a very volatile time.

As Peter mentioned.

Lumber prices have dropped significantly in the past month, but they are still well above any sort of historical averages.

The framing lumber composite the print right now still 50% higher than the five year average and go all the way up to the West B, which is still over 100% higher so still.

Still a very healthy environment for us as you know, we love Hi lumber prices.

So if they do stay elevated into next year.

That's a wonderful environment for us good margins via tick lower maybe but.

I'll still be reaping the benefit of higher margin dollars was we know at the end of the day is is the name of the game. So.

Feel good about the business and the short answer is there is nothing structurally that's changed in our business in the past few quarters that would.

Cause in my opinion, our margins to to vary from what they have historically in a in a more normal commodity environment.

Right, Okay. Okay I appreciate that.

And Peter I guess.

Yes.

Slightly different way and this has been more of a hypothetical but lets say.

Obviously going into next year, there's still going to be some some carryover tailwinds from inflation based on what we're what we're still saying in an environment, where we gradually normalize down to call. It.

For 50 to 500 lumber, which would still be above normal.

I know as you kind of normalize this lower based on what you're seeing in demand you guys have to $750 million target out for 2022, but you're you're exiting 2002.

20 at a really strong rate.

Is it.

Is it possible that you hit the 750 actually a year early in 21.

I guarantee you we will.

I mean, if you will that BMC results under a system.

[laughter], Yeah, I mean, I mean on a core basis [laughter].

Hey, there's a couple of factors here right I mean.

As far as I'm concerned that the good day, we closed at 750 is sort of in the rear view mirror and we'll we'll be working on putting a new number out there for everybody, but the reality of the impact of commodity prices on that is undeniable right course, we're going to be able to deliver sooner if we've got that tailwind.

But again our goal is really to focus on the core of the business, which is strong and is growing and we are going to continue to refine and commodities are going to be what theyre going to be.

I think if we if we spend all of our time talking about commodity prices and its impact on the bottom line. We'll have lost the broke out your business, but yes, I do think that could get us there sooner if they stay on.

Sure and certain certainly Didnt mean to focus too much on commodities part of the point there was just the underlying strength of the business given go past there as well, but yes, thanks ill turn it over.

All right. Thanks, Mike.

Thank you. Our next question comes from Trey Grooms with Stephens.

Hey, good morning, and congrats on the great results.

Thanks, Chris.

So first off.

Of course, it's stuck I guess sticking the number one your question there.

It's been pretty tied up until now and of course theres been some extended lead times out there first did that did that impact you at all in the quarter.

Are you seeing that improve at all and then kind of second to that is.

How you're thinking about inventory positioning as we enter kind of the slower seasonally slower winter months, where maybe some supply might loosen up.

Yeah, So I'll try and answer those in order, we certainly did see certain.

Market certain products, particularly certain species in legs get very very tight different parts of the year.

We like everybody else struggle it's.

In times to get everything that we wanted.

I think we feel pretty good about getting what we needed I think the numbers support that we have seen as the fall is started to two.

Set in.

That some of that product has absolutely become available in that and I think that's what you're seeing in the reflection of the prices in the spot for the.

Random lengths coming back down.

I would say, it's not back to normal yet.

But I would say that we are still running our business based on what we believe to be the right disciplines meeting we are going to limit our inventory, we're going to keep our inventory tied to our days demand, we're going to bring it down seasonally.

And then plan to bring it back office, we need to coming into next year, but.

Right now our you've seen a pretty good this may come up later in the conversation you've seen a pretty big increase in the value of our working capital.

I'll point to the fact, Thats basically all driven by the value of the product rather than the quantity of product. We have on hand, we tend to stay away.

Yeah. The trade off is that there's there's definitely been some not just and products. We we.

We deliver just across the board as you know there has been some.

Some product shortages in those continue.

I've heard instances in the Dallas market, where a bridge around 12 weeks.

People personally building homes that are that are waiting on doors and windows and.

If you look at the data the last couple of months.

This this may be the first time has ever had the definitely in recent years, where new home sales have outpaced starts and that's usually the other way around so.

The backlog is very strong, but I do think as Peter mentioned in the opening comments the cycle times aren't going to be extended because of the tightness of productive labor and that's.

It's a high class problem to have right and then just extends a it will extend this this backlog of this favorable environment into next year, which isn't a bad thing, but I do think it's important as you think about our business and the industry in general that we will likely see cycle times extended in the in the coming quarters.

Sure.

Make sense.

And then kind of on that.

You know with product shortages, you're you're calling out here you know outside of lumber.

There have been some pretty sizable price increases announced by some of the manufacturers across most of your product lines.

You mentioned doors, but also you know gypsum wallboard and some of the others.

So with that in mind, what what kind of inflation outside of lumber are you are you expecting.

As we go into next year do you think it will be higher than normal given the demand and some of the product shortages out there or just any color on on other types of inflation outside of lumber.

You are right there have been some price increases announced you'll have to forgive me if I wait to believe the gypsum guys.

The the impact is certainly inflationary right now.

The nature of.

The demand the interruptions to the supply the additional costs required for manufacturers to have to address the gold coast environment.

I certainly think there is a an inflationary environment.

The reality, though is.

What we've seen in the past and many of these business lines that secure for high prices is high prices and they definitely will.

Well slogan, so down or they'll begin to add capacity in order to normalize. It I don't think it will get carried away, but at the end of the day you know as a distributor were we will pass along those price increases and we think that makes our business healthier as we better leverage flow through.

Great One last one for me is.

It's on the Japan.

25% of Capex that you're kind of you're marking this year for.

For expansion of the value added.

Capacity this year, how much should that add to your capacity going forward I mean, how much does that.

That 25 million or so whatever the exact number shakes out to what does that translate into as far as capacity and is that 25% kind of a a good bogey going forward I know with the combined company, there's still maybe some questions but is.

Is that a pretty decent bogey for for that going forward, even with the combined company with the outlook that we have for housing.

Hi.

That's a great question I think that the mix of what we're investing in at any given time, we talked about Riverside and the new trucks facility. Those are pretty significant investments sort of one time the nature of the capacity expansion related to individual machine lines and facilities and.

Expansion of existing facilities is generally a little bit different so hard to give you a hard number.

But it certainly has been supportive of the expansion and value add that we've talked about.

The 25% in terms of a future investment.

<unk>.

That's an interesting question because on one hand, I would say yeah, I think that's reasonable based on what we've seen over the past couple of years, but also that the demand does seem to be increasing in that value add space and we may decide to accelerate our investments in that area just because it's got such a great return and in certain markets, particularly as we.

Combined these two businesses I think it's going to really unleashed our capabilities to to sell a broad swath of the market on value add and I could see that increasing over time, a little early yet.

Yes, but I certainly wouldn't I wouldn't be shy about putting more money money into that given our investment performance our returns today.

Yes, alright makes sense I'll I'll turn it over thanks, a lot Peter Thanks, Chad Good luck.

Thanks Ryan.

Thank you and you keep in mind or you May proceed star one to ask a question. Please limit yourself to two questions. Our next question comes from Keith Hughes, particularly securities.

Thank you I have two questions on the guidance for fourth quarter, some some eye popping growth there.

And given some of the variables I'm struggling to get to the number is there a substantial change coming in as DNA from third to fourth or anything else. You can tell me about how you're going to get the number.

Well the year end the fourth quarter results for SDMA are always a little dynamic as we true up of our year end reserves and sort of do our final cleanup. So there's always a bit of that you having I think the big story is not surprise anybody is the impact of commodities and what that.

Yes.

If you look at our business we've got.

You know, 30% to 40% of our products are exposed to that commodity fluctuation and with those currently being up basically double where they were last year.

You've got a pretty significant impact to the business.

And that of course is going to reflect in the nature of your SGN a fall through your percentages.

There is a there was an impact right the nature of what we've seen in the.

You should rates going up and down the leverage is is certainly benefited but you also have to the required reserves in the business and the increased commission dollars associated with those sales so little bit of flexibility.

Little bit flexing, rather in those numbers, but nothing material has changed as or were there some area of concern.

Okay, the price seven 7% in the quarter.

Be substantially higher commodity price and the four quarters of playing a role is that correct.

Oh yeah.

Yeah, Yeah, okay.

Double underline yeah.

Couple of general idea they go.

Second question.

Looking a little bit so looking a little bit longer term you piloted in several answers the backlog and were saying that you know I'll throw all throughout my my coverage.

Do you think this is going to be continued she said high class problem to deal with all through next year is that how long it's going to take to clear this up or is that something we could early spring you should get more in that lead times have come down.

No.

I would say it should certainly carriers to mid year.

No you get you get beyond that it gets a little buzz Neal a lot can happen election years, Australia.

But I would say all in all it's shaping up to be a should be pretty good demand for 2021 first half.

I wouldn't say, it's in the bank that is looking really good but it's just really hard to predict this business when you get beyond six or eight months.

Okay. Thank you very much.

Thanks.

Thank you. Our next question comes from Steven Ramsey with Thompson Research group.

Hey, good morning on.

You add.

Some questions on or the supply chain disruptions.

In the industry are they pushing more builders to use value add products.

And as you.

Try to it.

Expand your value add product business are there any supply issues in getting the equipment that would maybe slowed down your investment plans to grow that business and maybe slowing capex.

Maybe than you would like to go like to grow faster.

Well I think the opportunity for expanding value added increasing demand and value add is usually around the labor side right.

In most cases so.

While the product is not been the big issue. It certainly does limit their ability to sort of do.

Do it themselves when they can't get access we have very good relationships with our vendors.

We partner very closely with both of the sell through product vendors, but also the machine vendors.

And do you decide that we are I think they see us as a good customer and so we work with them to make sure our orders for the equipment that we need or in early and that we have a pipeline that were ordering.

Ordering each year so.

Less concerned about our access although you know let's face it all manufacturing has been pretty disrupted. So that's something that we're going to continue to stay well ahead of in order to make sure. We don't have issues in that regard.

But value added it's been a problem. This year you know.

Windows and doors in particular that have struggled and you know not to throw stones and it's been a very very difficult time.

But that is certainly an area, where we were hoping for a good solid recovery because we believe in the demand story.

Great and a follow up on that in the areas of the country that.

That are doing well high demand high starts activity.

You don't have as much value add exposure in those areas.

Do you plan.

In the next six to 12 months to Greenfield or open more or expand value add capacity in those areas or does.

The acquisition of BMC get you into those areas.

To to maybe a degree that you would like.

Yeah, it's a mix.

You know some some markets it absolutely helps us and were excited about we're going to be able to do together, we'll be able to add capacity I mean, the reality is that the capacity in the market is constrained it's because all of us are already constrained so that will be a different challenge.

Those markets, where we don't play as much there may be opportunities to do some of that.

You know it.

There is a lot to say grace over right now.

Great and then last quick one multifamily activity and timing helped Q3 is it a benefit in Q4 in early 2021.

Yeah. So multifamily we think we'll we'll settle down a little bit. We certainly were benefited by some projects that came through the multifamily team has done a really nice job for us.

We think it will it will slow down a bit but continued to be a.

A good area for us I don't were not anticipating I know that there Vince.

Market forecasts out there that are pretty.

Pretty depressing, we don't think it will be that bad for us, but it's certainly an area of the market you know as you get closer to commercial those larger scale projects have been more impacted by.

By code.

And that mix of the marketplace than some of the smaller areas, where we tend to focus for multifamily. So we're feeling pretty good about it a pretty small part of our business overall, but we think it will be a tailwind.

Got you thanks.

Thank you. Our next question comes from Rueben Garner with the benchmark company.

Thank you good morning, everybody.

He to harp on the harp on the commodity question, but I do have a clarification I think there's some.

I don't know if concern is the right word, but but questions around how much of your EBITDA strength in the back half of this year was driven by lumber.

Normally you guys have a.

Profit pressure during these rising pricing.

Nice environment does that has that increased been so dramatic that that even though you've got that gross profit margin drag, but the net of.

Higher commodity prices has been a positive for you on a year over year basis in a substantial way and if so could you could you quantify how much you know a net benefit to EBITDA in your in your fourth quarter and third quarter results.

So.

To answer your question I would say the first part to your question is around.

Kind of the performance of the business in terms of pricing.

We certainly did better than we had done in the past I think there are a couple of the main reasons for that.

The first of which is.

I I have.

Tremendous gratitude and operation for ARPU in terms of being able to execute utilizing some of the tools weve been working on utilizing all the experience that our teams have been very.

Very proactive very aggressive in terms of responding to the marketplace.

Getting those prices change quickly managing the costs of the U.

Ordering doing it in a very disciplined and.

Quick reacting way I think was the biggest impact I will also say that we certainly benefited from the headline nature of those commodity price increases there wasn't anyone who didnt no there wasn't anyone who could say well I'm not going to buy from you because it's expensive it's like okay, well you're buying it from anybody.

It's either because weve got a good position we can get you the product that you want if you would like it. This is what it costs. So I think that.

Those combination of factors certainly was a huge benefit.

And the reason why we performance goals.

We generally don't try and break out for you the exact impact of commodities.

From an EBITDA perspective.

I've talked about.

How much we felt was impacting for the third quarter and that 7.2% range. We think the fourth quarter just to be explicit will be in the 25% to 35% of our growth will be attributed to commodity inflation in the fourth quarter.

Just as a general rule of thumb, we've talked about all fall through not 12% to 15% range being roughly true for the impact of commodities up or down as well. So if you want to use some rough numbers. That's it that's a good way to think about it.

Although I will tell you the exact math is a bit more painful yeah.

Just to clarify the 25% to 35% is Q4 over Q4 sales growth, we expect to come from commodity inflation.

It's big enough forgot because.

Yes.

Okay. Yeah that was very helpful and then shifting gears away from commodities.

I'm sure you're tired of hearing about I into that.

The.

Next year.

Something that's been a drag for the whole industry over the last several years has been the size.

Of homes shrinking I think it's been kind of a low single digit volume drag for everybody and I think you guys have seen that as well are you seeing or hearing and opportunity for things to go the other way how big of an opportunity from us.

Volume benefit for for your products do you think you can get out of out of some of the bigger the return of the bigger luxury houses in some of the suburban markets.

Well couple of things, yes, I do think homes have gotten smaller it feels like maybe that starting to the bottom out now, but you know I don't I don't worry about that a whole lot I've said many times over the years. The only way you get back to a normal building environment of a million million one single family House.

This is as you've got to have that mix of smaller homes and that's what we've been missing.

Really since this recovery started and so to us. It's it's it's a good thing you know it gets you to that higher flow through it gets to the throughput on your gen under the homes coming through the system and yes. There is a there is a higher mix of smaller ones, but again, the only way you get to those historical averages to have that proper balance and we've just been missing that.

I read the articles that no people are now nasty want a bigger home after being trapped in.

I think we'll have to see.

There's there's maybe hope that things level out I'm not sure it turns into a tailwind because of which I was talking about we need those smaller homes. It will get them I think that expansion of that starter home part of the industry is great news long.

Long overdue.

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Got it thanks, guys congrats on the quarter and a good luck heading into the holiday selling season and literally thanks. Thank you. Thank you.

Thank you. Our next question comes from Sheldon Clark with Deutsche Bank.

Hey, Thanks for squeezing me in and so you saw 7% organic sales growth in the third quarter call, it nine or 10% goals, including M&A.

But total at CNN. It was only about 3% and looks like it will be down in the fourth quarter just based on your guidance I know you talked about some.

True up there so maybe that's not the best way to think about it but but moving forward.

If you can continue to generate this sort of mid to high single digit organic growth rate ignoring commodities for a second how can we how should we think about the relationship.

In that scenario between S., DNA and volume growth.

Yeah. So we have historically talked about SG Navy in about 70% variable about 30% fixed.

Now the unique dynamic that you alluded to is this idea that it's that's based on real volume and not the sort of big area to use of commodities. If you will so that's the only adjustment I would I would advise you to make sure you're keeping track of but yeah. We certainly have seen great leverage as a result of the expansion.

Commodities as well as great leverage off of the core.

The core organic growth.

And I think you commented that.

As you know it was going to be down in the fourth quarter and I don't think Thats. That's correct I think when you layer in the the sales growth the topline growth, including the inflation you will see that it's probably not.

Okay. That's helpful. Yes, I think on this understating the commodity impact and.

And then kind of Oh, yeah, just higher level question, but Chad you talked about going into some of your more local markets and hosting these town halls.

And you mentioned just briefly that you are excited about.

Some of the capabilities and complimentary aspects of the merger.

So could you just give us a little bit more color on maybe what you learned.

Throughout this process and you know whether you're thinking about the potential topline synergies or any any differently now that you're kind of you know a couple of more months into the process and you have had these experiences.

You know meeting with some of the local teams and things like that.

Sure Yeah, what was really good to see as you go into some of these and we were visiting primarily to even the markets, where we overlap and mainly major major markets, but I'm really good to see the geographic footprint. So you know just top of mind. There you can see the.

Potential and logistics savings, where you know our footprint might be more focused on the south into town and their footprint might be more focused on the north end. It certainly is going to give us some some ways to optimize our delivery.

From a product selection standpoint.

We would see a a facility where they're they're very big they have a very big ready frame operation for example, and we were very big and components and they may also have a large millward facility and so when you look at these in these major markets, where we overlap just the completeness of the product and service offerings, we can offer our customers.

And then how much better we will be positioned from a geographic standpoint to deliberate that's what's your after right you want to be able to serve your customers with a full breadth of offerings, but also in a in the most efficient way you can and so we saw a lot of examples of that and then not to mention just just the enthusiasm and in many cases.

ER there was almost a little mini family reunions going on when.

We saw some people that you know we've traded employees over the years and they've got a lot of talented people. We've got talented people and assist its really great to think about you know really will be the 18, when we put these two companies together.

Got it and in that example, where you know you've got a facility in the north and they have one in the south.

I'd have slightly different product categories. How does historically has that changed or the market share or pricing dynamics in those sort of specific areas.

Well.

You know if you're a builder clearly you typically going to happen when I have more than one supplier right the system actually keeping everyone honest, but the advantage there yeah.

You know by offering that the full breadth of products the builders.

We want to position the company, where we can make the builders lives as easy as possible and and make it easier to do business with us than any of our competitors and so the more we can offer that as I said that broad expansion of products and services. The more likely they are going to want to do business with us that will that tend to lead to additional share of wallet, yes. It should.

The.

Price, maybe you know, there's still going to be other competitors in the market.

No theres still going to keep me honest, but.

But it's more about being that go to supplier for the for the builder and making their lives as easy as possible in an easy to do business with us versus any of our competitors, that's what you're after and that's what.

That's why these two businesses will complement each other so much and help us achieve that and a lot of these overlap markets.

[noise] yeah. It makes sense I appreciate the questions. Thank you.

Thank you.

Thank you. Our next question comes from Ryan Gilbert with TPH.

Hey, Thanks, guys I just to drastically on 2021, EBITDA, a commodity price impact maybe a different way on looking back to the last period of rapid rapid commodity price inflation and then subsequent deflation 28, and 2019 I thought that was interesting.

About 2019 is that even though you experienced a commodity price headwind on revenue you were still able to grow adjusted EBITDA throughout.

Throughout the year. So you know looking at at third quarter and fourth quarter.

Gross margins, you know even less impact from from commodity prices than what you experienced in 2018, just just wondering what your confidence level is that you can continue to grow.

Adjusted EBITDA, if if you know this commodity price tailwind turns into a headwind in the in the quarters.

Quarters coming.

Yeah. It's a great question I think that each <unk> each cycle is a bit different the extreme nature of this one is.

It's certainly impacted the industry differently, we're going to be the different demand profile I would say going into next year, so that potentially change things as well.

We've got to wait and see how it plays out I do feel really good about the underlying core, though right our ability to manage pricing our ability to get good leverage.

On the business our ability to.

Continue to grow the underlying operations in this strong demand environment and the movement towards value I think are all very.

Very positive.

Tailwinds or or data points for that discussion, but I would just have to wait and see.

Okay got it and then second question on structural components I mean, we've heard from you and from many home builders that cycle times are extending and it seems like Ah you know builder should be looking for opportunities to improve their their cycle times or their productivity and it seems like at least in theory.

He structural components should offer that on so I'm wondering if your builder customers or more or if you're getting more inbounds from homebuilders about using structural components tech kind of speed up the framing process or if you know homebuilders are more receptive cheap to.

To your sales teams, who are we're selling structural components.

Yes, as we've said all along shortages in labor creates the perfect environment to drive builders, who aren't currently using components to consider them and that's that's certainly in an environment, we're still in and combine that with just the overall demand in the existing customers that are using components.

And just the the.

The incremental number of homes.

They are wanting us to run through our component plants as as Peter said earlier the backlogs are.

Very strong right now so that should be a.

Very value add conducive environment for the next few quarters.

And do you think that the that you know the recent surge in demand and extension and cycle times has had.

Some some noticeable impact in builder demand for structural components.

Yeah, I wouldn't say it's off the charts.

We've got cost as you can imagine we've got customers that have traditionally used components.

And they are keeping us very busy right now with that with the increase in and starts that we've seen in recent months, but but yes. Certainly there is there's been an uptick in an incoming inquiries in demand and as I said I think as I don't see the labor issue getting better anytime soon especially with the strong surgeon start so as I said I think thats going.

Continue to be a pretty favorable environment for us.

Okay, great. Thanks, very much for the time.

Thank you.

Thank you. Our next question comes from cooking your way D.A. Davidson.

Thanks, and good morning, everyone. Appreciate you squeezing me in I just wanted to start off I mean with with two pretty remarkable periods of volatility in commodities over the last three years is there anything internally or that your customers are pushing to do to maybe change some of the backward looking price locks and.

Realize it's not completely standardized but is there anything creative or something.

That people are trying to do to maybe smooth it out a bit.

Well, there's certainly been a lot of conversation about it no question.

I think there are some ebbs and flows in some customers who have gone away from the price locks or tried to.

You know I think some some of us in the industry and the distribution space have looked for ways to create.

A bit more stability in terms of the way, we buy whether it be directly from the mills are contractual relationships. Unfortunately, I'm not sure the.

The options markets are really all about helpful. Just based on the way that they work right now so there yeah, there even the discussions about how that might change in the future I'm optimistic that you know in our new.

Our new structure as a combined entity with BMC that might be something we could even continue to follow down that path or our ability to be a positive influence stabilizing influence on this industry I think is enhanced.

With our scale and with our ability to act in a coordinated way. So we will absolutely continue to look at that and certainly some interesting models based on what some folks have done out there.

Okay, Okay, Thats interesting and.

And just my second one on earlier question touched on the $750 million EBITDA target can you just remind us within your own control as far as the operational.

Excellent targets, where you stand as far as putting those in place and.

The biggest buckets of opportunity that remain.

Sure Yeah, I mean, we had talked about a roughly $65 million target out there for ourselves.

I think we're probably about halfway based on what we talk through it up to a prior year.

Continuing to make progress in that space.

We certainly see the best opportunities the biggest opportunities for ourselves.

In a couple of key areas, we think that that pricing management and pricing discipline sort of taken a consistency.

Consistencies in efficiencies out of our process is still being a real potential.

Forward looking benefit for our business excited to see what we can do partner together with BMC in that way as well.

And then I think there our ability to continue to enhance our internal operations using.

Digital tools processes, whether that be as we interact with our customers, but even back office, we certainly still see tremendous value going forward leveraging best practices leveraging technology and then a combination of those two things we think will be really impactful so certainly feel.

Very good about our ability to deliver and go beyond those targets, we issued Bakken Bakken 18, so sir.

Certainly expecting that to be an important part of the way the business is going to run post merger as well.

Got it got it okay I appreciate all the details and good luck in the fourth quarter here.

Thank you. Thank you appreciate the questions.

Thank you. This concludes today's question and answer session I'd like to now turn the conference back to Mr. Chan for any closing remarks.

Thank you once again for joining us today, and we look forward to updating you on our future results and the progress on our our merger with BMC.

If you have any follow up questions don't hesitate to reach out to bid or Peter have a good day. Thank you.

Thank you ladies and gentlemen. This concludes today's presentation you may now disconnect.

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