Builders FirstSource, Inc.

Good day and welcome to the Builders First Source third quarter 2020 conference call. At this time, all participants are in a listen-only mode. Following the company's remarks, we will conduct a question and answer session. Today's call is being recorded and will be available at www.bldr.com. It is now my pleasure to introduce Mr. Bennett Sungbee, Vice President, Investor Relations. Please go ahead.

Thank you, Stephanie. Good morning, and welcome to the Builders First Source Third Quarter 2020 Earnings Conference Call. With me on the call today are Chad Crowe, Chief Executive Officer, and Peter Jackson, Chief Financial Officer. A copy of the slide presentation referenced on this call is available on the Investor Relations section of the Builders First Site website at dldr.com. Before we begin, let me note that during the course of this conference call, we may make statements concerning the company's future prospects, financial results, business strategies, and industry trends. Such statements are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995 and are subject to certain risks and uncertainties which could cause actual results to differ materially from expectations. Please refer to our most recent form, 10-K, filed with the Securities and Exchange Commission and other reports filed with the SEC for more information on those risks. The company undertakes no obligation to publicly update or revise any forward-looking statements. The company will discuss adjusted results on this call. We have provided reconciliations of non-GAAP financial measures to their GAAP equivalent in our earnings press release and detailed explanations of non-GAAP financial measures in our Form K filed yesterday, both of which are available on our website. I will now turn the call over to Chad Crow.

Thank you, Bennett. Good morning, and thank you for joining us on our third quarter earnings call. As the pandemic continues, I hope you and your families are staying safe and healthy. Our thoughts 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 quarters, 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 create the nation's premier supplier of 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 closely 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, Dave Flutman 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. In 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 company's capabilities in real time and envision 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 great pride to see our hardworking team members across the country whose efforts are directly responsible for putting us in the successful position we are in today. Both Dave and I enjoyed getting to interact with so many team members and seeing their excitement for future opportunities we take our combined business to new heights. In terms of timing, thus far the deal is progressing as expected. The merger planning work that's 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 DOJ. Also in October, we filed our Form S-4 with the SEC. We are working diligently with both agencies. Once we have completed these two regulatory milestones, there will be a required 20 working day notice before Builders First Source and BMC request their respective shareholder approvals. This keeps us on track to close the merger in late 2020 or early 2021. At this point, I could not be more pleased with our significant strides towards winning together as 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 accomplished during the quarter. First, the momentum we carried into the third quarter continued, with performance ultimately being better than we had anticipated. The home building markets have been resilient. Improving housing starts, record low mortgage rates, and a shift towards suburban living are 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 in 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 robust demand in much of the country. Our team delivers 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. While housing demand has accelerated rapidly, we have also seen commodity prices reach record heights. Commodity inflation contributed approximately 3% to sales, and 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. Through our focused execution, we have remained appropriately resourced to capture rising demand in a disciplined manner. This has 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 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 will no doubt prove to be efficiency-enhancing investments as we move into our next generation of growth. And finally, amongst the many things we can do in merger with BMC to our team members, customers, and shareholders, we will continue to expand our network of value-added off-site component manufacturing facilities, which are core to our collective strategy. Post-combination, that will continue to be a focus of our combined growth. With the 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 a state VR greenfield trust plant in Riverside, California, extending our industry-leading position to 66 manufacturing facilities. Whether through new facilities, new trust lines and existing plants, door facility expansions, or other system enhancements, these differentiated offerings offer industry-leading value-add capacity. and 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 Builder's First Source. 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 Builder's First Source within our industry. It has been an element of our success in 2020 and will continue to be a core focus after we complete our transformational merger with BMC. I will now turn the call over to Peter, who will review our third quarter results in more detail.

Thank you, Chad. Good morning, everyone. I would like to start by also recognizing our team's 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 then 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%. Core organic excludes acquisitions and commodity impacts from net sales to give an indication of the underlying performance of the business. We experienced accelerating 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 in total increased by 15.9%. Our value-added product categories continue to perform well within our respective markets. I will note, however, that the impact's of both commodity inflation and COVID-19 in 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. The gross margin of $570.7 million in the third quarter of 2020 increased by over $29.5 million over the third quarter of 2019. Our gross margin percentage was 24.9%. which was well ahead of our expectations, though down 240 basis points from the third quarter of 2019. The margin percent decrease on a year-over-year basis was attributable to sharp increases in commodity prices. The commodity inflation and 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. Over the long term, higher prices benefit our business. However, price fluctuations, especially in commodities, can cause significant swings in our results. Commodity cost inflation causes short-term gross margin percentage headwinds when prices spike relative to our short-term pricing commitments that we provide customers. Additionally, higher prices in commodity products have a negative mixed impact on gross margin percentages. As mentioned, I am pleased with our team's ability to mitigate unfavorable impacts this quarter through a combination of focused execution and disciplined pricing. As we near the end of the quarter, commodity prices started 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 $300,000 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 a higher outstanding balance as we proactively increased our liquidity and financial flexibility. Third quarter EBITDA increased $24 million from a year ago. to $184.3 million, an increase of 15%. This is the highest quarterly EBITDA in our history, driven by the top-line growth combined with the reduction in variable expenses related to commissions as well as lower travel and fuel costs. EBITDA margin held steady at 8% compared to the prior year period. Adjusted net income for the quarter 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 driven by improved operating results. On slide 6, the strength of our business was evident again in the third quarter. Our team grew net sales across four of five product categories, led by lumber, given the dramatic escalation in costs. 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. Including 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% in our single-family customer and market compared to the prior year, helped by accelerating demand in the majority of our region. Market tailwinds and underlying economic conditions continue to be very supportive of demand. 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. Organic growth in the R&R and other end market grew by 7%, as we continue to see relative strength in the western part of the country. Multi-family core organic increased by 18%, largely due to the timing of large projects. Turning to our outlook on slide 8, our results in the first nine months demonstrate a positive home building environment that is supporting rising demand across our footprint, which continued into October. Year-to-date results reflect our the extremely dynamic commodities market from both a 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 place in 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 strength in the fourth quarter and beyond. The Builder Confidence Index reached an all-time high of 85 in October. We estimate significant pent-up demand from increased household creation and significant underbuilding of single-family homes over the past decade. Mortgage applications continue to climb, with mortgage rates also near all-time lows, and existing home inventories also near all-time lows of three-month supply. We are seeing the benefit of residential construction catalysts in nearly all localities where we operate outside of the Northeast. With this 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 continue to manage our business with a prudent growth assumption, which accounts for the lag before housing starts translate into units under construction, and ultimately completions. In recent months, factors such as tight labor and material scarcity have extended builder construction cycles. To put that in perspective, over time, completions will approximate roughly 100% of starts, but at the moment, completions represent only approximately 80%, or 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 to $115 million range. With our growth projects underway again, we reiterate our expectation for capital expenditures to be in the $100 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 Chad for his closing remarks.

Thank you, Peter. This is an exciting time for Builders FirstSource. We are on path to close out a record year with 2020 adjusted EBITDA 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 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 are all very pleased to welcome the BMC team to the Builders FirstSource family. Our accomplishments accomplishments to this point have only strengthened my conviction in the merits of this merger. This merger will allow us to deliver solutions that make our customers more productive and efficient through deeper and more integrated relationships than ever before. Value-added offerings will continue to represent the largest portion of our business and the focus of our investments. 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 aligns with our shared growth strategies and occurs at an optimal time for both companies to create significant value through 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. I am 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. If you'd like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question. Our first question comes from Matthew Bully with Barclays.

Good morning. Thanks for taking the question. Good morning, Matt. Congrats on the results. So I wanted to start out maybe pressing on the value-add product performance a little bit. You know, the 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. Um, you know, but I think last quarter that there was some underperformance, which you talked about related more to the West and to 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. Thank you.

Sure. Yeah. So, um, There are a couple of layers to this. This has been a pretty dynamic year. So as we talk about the beginnings of COVID's impact on our business, the parts of the country where we were hardest hit, the Northwest, the Northeast, and Florida, were those areas, for the most part, that were seeing government shutdowns, right? So everything was shut down or significant parts of the business were shut down. Right. a lot of exposure to value-add in those businesses. So we saw the greater than normal or greater than average negative impacts on value-add. As we got into the summer and through the back half of the year, the geography impact was still true from the perspective that I would say Northwest bounced back pretty quickly after the COVID reopening hit. 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 different – I'm sorry, that exposure to value-add, is different in those markets than it is in the rest of the country. Another way to look at it is if you think about those parts of the country that have grown the most and have the best performance. If you think about the South, Texas is a great example. In many ways, electing not to participate in the downturns related to COVID, that's a market that doesn't have as much exposure to that value-added product. You know, there are some other factors at play. We talked a little bit about the extended build times. We think that the home builder cycle, despite the rapid increase in starts, is extending. We've heard that comment from a few folks, whether it be due to product availability or labor availability. We think that has also shown a bit of an impact, particularly on products that we see towards the back half of the build cycle that's included in value-add for us. You know, all in all, we're not concerned about it we continue to monitor it it's important obviously to our strategic vision of the company but all of our data says we have reason to be confident we're positive about our backlogs we think that you know the overall environment is very very positive and we see it picking up again um but certainly there have been some ski bumps you know we all know how hard it is to run a manufacturing operation in general and during the age of the covid uh you know that's a That's 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. Backlogs look good. Demand looks good. I haven't seen 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 you have, Peter. And secondly, I wanted to ask just on the On the merger, you know, it sounds like the timeline's on track. But, you know, you've continued to obviously progress with the merger planning. So I guess I'm just curious if there's 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, you know, maybe any finer points on the synergy potential, just You know, as you've continued to dig deeper, you know, just curious what kind of the latest is on the operations.

Thank you. Yeah, I would kind of sum it up 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's a lot of excitement out there. amongst our team members on the opportunities that we're going to have as a go-forward company. But no real surprise is 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're 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, yeah, it's going as expected, which is a good thing.

Great. Thank you, Chad. Thank you, Peter.

Thank you.

Thank you. Our next question comes from Mike Dahl with RBC Capital Markets.

Morning. Thanks for taking my questions. Tremendous results. It's a good way to end the year. First question just around margins, and this is more thinking towards 2021. So, you know, as you noted, lumber has, you know, started to move lower and given your lag, you know, would you think about 2021 as being back in that normal 26 to 26.5% range at this point? And I guess similarly, you know, any thoughts on, you know, there's always moving pieces around SG&A, but you guys have done great. a great job keeping costs under control and leveraging the top line. So any thoughts on kind of where we should be thinking on normal S&A?

Yeah, that's a great question. And, you know, you've heard me make this half-joking comment before. If you can tell me what commodities are going to be, I'll tell you what my margins are going to be. It's a really big question mark. You know, that – That run-up that we saw this year in commodities is unprecedented. And while it's turned, you know, it's certainly not back to historical norms. We're quite elevated. And I think the market in some ways is still digesting it. It's certainly still passing through in our pricing. We've read some of the materials that the home builders have put out there about what they're doing with their pricing. You know, some people have maybe 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. You know, personally, I think they're missing out in terms of the opportunity and the demand that's out there. We're motivated to build whatever we can and get it out. And I think that dynamic as it evolves over the next six months will be impactful on us, no doubt. But the core of the business, going in terms of being ready to deliver on that demand. You know, the likelihood that we're going to see, you know, a return to those really high lumber prices is low. So I think it's fair to say that we'll see some tailwinds associated with the deflation for a bit of time. But, you know, it's so volatile and so dynamic in different parts of the country. I'd say at this point, I'm not comfortable putting a normal out there for you. what you're 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 other big factor is putting our two businesses together and seeing what the combined entity starts to perform at. That'll be a critical piece to that as well.

Yeah, nothing has structurally changed with our business, obviously, but it is a very volatile time. As Peter mentioned, higher than a five-year average and go all the way up to OSB, which is still over 100% higher. So still a very healthy environment for us. As you know, we love high lumber prices. So if they do stay elevated in the next year, that's a wonderful environment for us. Could margins be a tick lower? Maybe. But we'll still be reaping the benefit of higher margin dollars, which we know at the end of the day is the name of the game. So feel good about the business and the short answer is there's nothing structurally that's changed in our business in the past few quarters that would cause, in my opinion, our margins to vary from what they have historically in a more normal commodity environment.

Right. Okay. I appreciate that, Chad and Peter. I guess I'll ask a slightly different way and this is then more of a hypothetical, but let's say Obviously, going into next year, there's still going to be some carryover tailwinds from inflation based on what we're still saying. In an environment where we gradually normalize down to, call it, 450 to 500 lumber, which would still be above normal, and OSB kind of normalizes lower, based on what you're seeing in demand, you guys have the $750 million target out for 2022, but you're exiting 2021. 20 at a really strong rate. Is it possible that you hit the 750 actually a year early in 21? I guarantee you we will. I mean, on a core basis.

Hey, there's, I mean, a couple factors here, right? I mean, As far as I'm concerned, the day we close, that $750 is sort of in the rearview mirror, and we'll be working on putting a new number out there for everybody. The reality of the impact of commodity prices on that is undeniable, right? Of 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 You know, I think if we spend all of our time talking about commodity prices and its impact on the bottom line, we'll have lost a bit of value in this business. But, yes, I do think that could get us there sooner if they stay high.

Sure. And certainly didn't mean to focus too much on commodities. Part of the point there was just the underlying strength of the business giving you a path there as well. But, yeah, thanks. I'll turn it over. All right. Thanks, Mike.

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

Hey, good morning, and congrats on the great results. Thanks, Trey. So, first off, of course, you know, I guess sticking to lumber, one more question there. You know, it's been pretty tight up until now, and, you know, of course, there's been some extended lead times out there. First, did that impact you at all in the quarter? Sure. Have you seen that improve at all? And then kind of second to that is how you're thinking about, you know, inventory positioning as we enter kind of the slower, seasonally slower winter months where maybe, you know, some supply might loosen up.

Yeah. So I'll try and answer those in order. We certainly did see certain changes. Certain markets, certain products, particularly certain species and lengths, get very, very tight during parts of the year. We, like everybody else, struggled at certain 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 has started to set in, that some of that product has absolutely become available. And I think that's what you're seeing in the reflection of the prices and the spots 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, meaning we are going to limit our inventory. We're going to keep our inventory tied to our day's demand. We're going to bring it down seasonally. and then plan to bring it back up if we need to coming into next year. But right now, 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 that's basically all driven by the value of the product rather than the quantity of product we have on hand. We intend to stay lean.

Yeah. To try out with that, there's definitely been some – not just in products – across the board, as you know, there's been some product shortages and those continue. I've heard instances in the Dallas market where bricks are out 12 weeks and I know people personally building homes that are waiting on doors and windows and, you know, if you look at the data the last couple of months, this may be the first time it's ever happened and definitely in recent years where new home sales have outpaced starts and it'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 are going to be extended because of tightness of product and labor. You know, it's a high-class problem to have, right? And it just extends – it will extend this backlog of this favorable environment in the 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 coming quarters.

Sure. Makes sense. And then kind of on that, you know, with product shortages you're calling out here, you know, outside of lumber, you know, there have been some pretty sizable price increases announced by, you know, some of the manufacturers across most of your product lines. You know, you mentioned doors, but also, you know, gypsum wallboard and some of the other stuff. So, with that in mind, what kind of inflation outside of lumber are you expecting as we go into next year? Do you think it'll be, you know, higher than normal given the demand and some of the product shortages out there, or just any color on other types of inflation outside of lumber?

You're right there. There have been some price increases announced. You'll have to forgive me if I wait to believe that just some guys. 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 whole COVID environment, I certainly think there is an inflationary environment. The reality, though, is what we've seen in the past in many of these business lines is that secure for high prices is high prices, and they generally – will slow themselves down or they'll begin to add capacity in order to normalize it. I don't think it'll get carried away. But at the end of the day, you know, as a distributor, we will pass along those price increases, and we think that makes our business healthier as we better leverage the flow through.

Great. One last one for me is on the 25% of CapEx that you're kind of earmarking this year, for expansion of the value-added capacity this year. How much should that add to your capacity going forward? I mean, how much does, you know, 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 good bogey going forward? I know with the combined company there's still maybe some questions, but is that a pretty decent bogey for that company? going forward, even with the combined company with the outlet that we have for housing?

You know what? That's a great question. I think that the mix of what we're investing in at any given time, I mean, we talked about Riverside and the new trust facility. Those are pretty significant investments, sort of one-time, the nature of the capacity expansion related to individual machines, lines, and facilities. Expansion of existing facilities is generally a little bit different, so it's kind of hard to give you a hard number, but it certainly has been supportive of the expansion and value-add that we've talked about. You know, that 25% in terms of a future investment, 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 I'll also admit that, you know, 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 combine these two businesses, I think it's going to really unleash our capabilities to sell a broad swath of the market on value-add, and I could see that increasing over time. A little early yet. to be honest, but I certainly wouldn't be shy about putting more money into that given our investment performance returns today.

Yep. All right. Makes sense. I'll turn it over. Thanks a lot, Peter. Thanks, Chad. Good luck.

Great.

Thanks, Greg.

Thank you. As a curriculum monitor, you may press star 1 to ask a question. Please limit yourself to two questions. Our next question comes from Keith Hughes with Truist Securities.

Thank you. I have some questions on the guidance for fourth quarter. 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 SG&A from third to fourth, or is there anything else you can tell me on how you're getting the number?

Well, year-end. the fourth quarter results for SG&A are always a little dynamic as we true up all of our year end reserves and sort of do our final cleanup. So there's always a bit of that. Yeah. I mean, I think the big story is not surprised anybody is the impact of commodities and what that does. You know, 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, you know, 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 SG&A fall through, your percentages. You know, there is an impact, right, the nature of what we've seen in the commission rates going up and down. The leverage is certainly benefited, but you also have the required reserves in the business and the increased commission dollars associated with those sales. So a little bit of flexibility, a little bit of flexing, rather, in those numbers, but nothing material has changed. Was there some area of concern?

Okay. The price, 70% of the quarter, I assume it's going to be substantially higher commodity price in the fourth quarters playing a role. Is that correct? Oh, yeah. Yeah. Yeah. Okay.

A double underline. Yeah.

A double underline. Yeah. There you go. Second question, looking a little bit longer term, you've highlighted in several answers the backlog, and we're seeing that all throughout my coverage. Okay. Do you think this is going to be a continued, as you 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 could get more and the league times could come down?

No. I would say it should certainly carry us to mid-year. You know, you get beyond that, it gets a little fuzzy. A lot can happen, election year, et cetera. 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, but it's 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, Steve.

Thank you. Our next question comes from Stephen Ramsey, the Thompson Research Group. Hey, good morning.

On value-add, maybe some questions on are there supply chain disruptions in the industry? Are they pushing more builders to use value-add products? And as you try to expand your value-add product business, are there any supply issues in getting the equipment that would maybe slow down your investment plans to grow that business and maybe slowing CapEx than you would like to go, like to grow faster?

Well, I think the opportunity for expanding value-add and increasing demand in value-add is usually around the labor side. Right? I mean, in most cases, the supply of the product is not then the big issue. It certainly does limit their ability to sort of do it themselves when they can't get access. We have very good relationships with our vendors. We partner very closely with both the sell-through product vendors but also machine vendors. And, you know, being – 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 are in early and that we have a pipeline that we're 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, you know, value added, it's been a problem this year. You know, windows and doors in particular have struggled. And, you know, not to throw stones at them, it's been a very, very difficult time. But that is certainly an area where, you know, we're hoping for a good, solid recovery because we believe in the demand story.

Great. And to follow up on that, in the areas of the country that are doing well, high demand, high starts activity, but 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 maybe a degree that you would like?

Yeah, it's a mix. You know, some markets it absolutely helps us, and we're excited about what we're going to be able to do together. We'll be able to add capacity. I mean, the reality is if 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, there's 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 and early 2021?

Yeah, so multifamily we think will 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'll slow down a bit but continue to be a good area for us. We're not anticipating. I know that there have been some market forecasts out there that are pretty depressing. We don't think it'll be that bad for us, but it's certainly an area of the market. As you get closer to commercial, those larger scale projects have been more impacted by We're feeling pretty good about it. Pretty small part of our business overall, but we think it'll be a tailwind.

Gotcha. Thanks.

Thank you. Our next question comes from Reuben Gardner with The Benchmark Company.

Thank you. Good morning, everybody. I hate to 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 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 price environments. Has the increase been so dramatic that even though you've got that gross profit margin drag that 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 quantify how much, you know, net benefit to EBITDA is in your fourth quarter and third quarter results?

So, to half your question, I would say that the first part of your question is around, you know, kind of the performance of the business in terms of pricing. We certainly did better than we have done in the past. I think there are a couple of main reasons for that. The first of which is I have tremendous gratitude and admiration for our team in terms of being able to execute, utilizing some of the tools we've been working on, utilizing all the experience that our teams have, been very proactive, very aggressive in terms of responding to the marketplace. getting those prices changed quickly, managing the costs and the inbound 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 didn't know. There wasn't anyone who could say, well, I'm not going to buy it from you because it's expensive. It was like, okay, well, You're not buying it from anybody else either because we've 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, you know, those combination of factors certainly was a huge benefit and the reason why we performed as well as we did. We generally don't try and break out for you the exact impact of commodities from an EBITDA perspective. was impacting for the third quarter, you know, in 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 have talked about our fall through in that 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 a good way to think about it, although I would 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 a big number.

Got it, because, yes. Okay, yeah, that was very helpful. And then shifting gears away from commodities, I'm sure you're tired of hearing about it. I am too. Next year, you know, something that's been a drag for the whole industry over the last several years has been the size of homes shrinking. You know, 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 that? an opportunity for things to go the other way? How big of an opportunity from a volume benefit for your products do you think you could get out of some of the bigger, the return of the bigger luxury houses in some of the suburban markets?

Well, a couple things. Yes, I do think homes have gotten smaller. It feels like maybe that's starting to bottom out now, but 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 houses is 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 a good thing. It gets you to that higher flow through. It gets you to that throughput under the homes coming through the system. And yes, There's a higher mix of smaller ones, but, again, the only way you get to those historical averages is to have that proper balance, and we've just been missing that.

I've read the articles that, you know, people are now nesting and wanting to bring their home after being trapped, and I think we'll have to see. I think there's, you know, maybe hope that things level out. I'm not sure it turns into a tailwind because of what Chad was talking about. We need those smaller homes, and we'll get them. I think that expansion of that starter and move up on part of the industry is great news. Long overdue.

Got it. Thanks, guys. Congrats on the quarter, and good luck heading into the holidays. Talk to you guys later on. Thanks. Thank you. Thank you.

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

Hey, thanks for squeezing me in. So we saw 7% organic sales growth in the third quarter, call it 9% to 10% growth, including M&A. But total SC&A was only up about 3%, and it looks like it's going to 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 moving forward – if you can continue to generate this sort of mid- to high-single-digit organic growth rate, you know, ignoring commodities for a second, how should we think about the relationship in that scenario between SG&A and volume growth?

Yeah, so we have historically talked about SG&A being about 70% variable, about 30% fixed. Now, the unique dynamic that you alluded to is this idea that that's based on real volume and not the sort of vagarities of commodities, if you will. So that's the only adjustment 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 of commodities, as well as great leverage off of the core organic growth.

And I think you commented that SG&A was going to be down in the fourth quarter, and I don't think that's correct. I think when you layer in the sales growth, the top-line growth, including the inflation, you'll see that it's probably not.

Okay. That's helpful. Yeah, I think I was understating the commodity impact. And then kind of a, you know, just higher-level question. But, Chad, you talked about going into some of your more local markets and, you know, hosting these town halls. And you mentioned just, you know, briefly that you were excited about, you know, some of the capabilities and complementary aspects of the merger. So, could you just give us a little bit more color on maybe what you learned and, you know, throughout this process and, you know, whether you're thinking about the potential, you know, top line synergies any differently now that you're kind of, you know, a couple 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 is as you go into some of these, and we were visiting primarily the markets where we overlap and mainly major markets, but 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 end of town and their footprint might be more focused on the north end. It certainly is going to give us some ways to optimize our delivery from a product selection standpoint. You know, we would see a facility where they're very big. They have a very big ready frame operation, for example, and we're very big in components and they may also have a large millwork facility and And so when you look at in these major markets where we overlap, just the completeness of the product and service offering we can offer our customers, and then how much better we will be positioned from a geographic standpoint to deliver it, that's what you're after, right? You want to be able to serve your customers with a full breadth of offerings, but also in the most efficient way you can. And so we saw a lot of examples of that. And then not to mention just the enthusiasm, and in many cases – 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 it's just, it's really great to think about, you know, it really will be the A team when we put these two companies together.

Got it. And in that example where, you know, you've got a facility in the north end and they have one in the south, you know, that have slightly different product categories. How does historically has that changed the market share or pricing dynamics in those sort of specific areas?

Well, you know, if you're a builder, clearly you typically want to have more than one supplier, right, just to make sure you're keeping everyone honest. But the advantage there is, you know, by offering that full breadth of products, a builder's We want to position the company where we can make the builder's life as easy as possible 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're going to want to do business with us. Will that tend to lead to additional share of wallet? Yes, it should. Price, maybe. You know, there's still going to be other competitors in the market. They're still going to keep you honest. but it's more about being that go-to supplier for the builder and making their life as easy as possible and easy to do businesses with us versus any of our competitors. That's what you're after, and that's why these two businesses will complement each other so much and help us achieve that in a lot of these overlap markets.

All right. Yeah, that makes a lot of sense. I appreciate the questions. Thank you.

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

Hey, thanks, guys. Just to ask the 2021 EBITDA commodity price impact maybe a different way. Looking back to, you know, the last period of rapid commodity price inflation and then subsequent deflation, 2018, 2019, I thought what was interesting about 2019 is that even though you experienced a commodity price headwind on revenue, you were still able to grow adjusted EBITDA, you know, throughout the year. So, you know, looking at third quarter and fourth quarter gross margins, you know, even less impact from commodity prices than what you experienced in 2018. Just wondering what your confidence level is that, you know, that you can continue to grow adjusted EBITDA if, you know, this commodity price tailwind turns into a headwind in the, you know, quarters coming in.

It's a great question. I think that each cycle is a bit different. The extreme nature of this one has certainly impacted the industry differently. We're going to be in a different demand profile, I would say, going into next year. That could 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 of our ability to manage pricing, our ability to get good leverage off the business, our ability to continue to grow the underlying operations in this strong demand environment and the movement towards value-add. I think we're all very positive tailwinds or data points for that discussion, but I'm going to 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. It seems like builders should be looking for opportunities to improve their cycle times or their productivity. And it seems like, at least in theory, structural components should offer that. So I'm wondering if your builder customers are more, or if you're getting more inbounds from home builders about using structural components to kind of speed up the framing process or if home builders are more receptive to your sales teams who are selling structural components.

Yeah, as we've said all along, shortages in labor create the perfect environment to drive builders who aren't currently using components to consider them, and that's certainly in an environment we're still in. And combine that with just the overall demand, existing customers that are using components, and just the The incremental number of homes, they're wanting us to run through our component plants. As Peter said earlier, the backlogs are very strong right now, so it should be a very value-add conducive environment for the next few quarters.

And you think that the recent surge in demand and extension of cycle times has had some noticeable impact in builder demand for structural components?

Yeah, I wouldn't say it's off the charts. We've got customers, as you can imagine, we've got customers that have traditionally used components, and they are keeping us very busy right now with the increase in starts that we've seen in recent months. But, yeah, certainly there's been an uptick in incoming inquiries and demand, and as I said, I don't see the labor issue getting better anytime soon, especially with the strong surge in 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 Kurt Inger with DA Davidson.

Thanks, and good morning, everyone. Appreciate you squeezing me in. I just wanted to start out, I mean, 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 blocks? And I 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. You know, I think there are some ebbs and flows. Some customers have gone away from the price blocks or tried to. You know, I think some... Some of us in the industry in 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 or contractual relationships. Unfortunately, I'm not sure the options markets are really all that helpful just based on the way that they work right now. So there are even discussions about how that might change in the future. I'm optimistic that, you know, in our new structure as the combined entity with BMC, that might be something we could even continue to follow down that path. You know, our ability to be a positive influence and a stabilizing influence in 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, that's interesting. And just my second one, an earlier question touched on the $750 million EBITDA target. Could you just remind us within your own control as far as the operational excellent targets kind of 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 talked through up until 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 taking the inconsistencies and inefficiencies out of our process is still being a real potential forward-looking benefit for our business. Excited to see what we can do partnered together with BMC in that way as well. And then I think there are abilities that 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 you know, deliver and go beyond those targets we'd issued back in 18. So, you know, 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. Appreciate all the details, and good luck in the fourth quarter here.

Awesome. 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. Chakra 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 merger with PMC. If you have any follow-up questions, don't hesitate to reach out to Ben and Peter. Have a good day. Thank you.

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