Good morning, welcome to Builders FirstSource's third quarter 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. Binit Sanghvi, Vice President, Investor Relations. Please go ahead.
Thank you, Chantelle. Good morning, and welcome to Builders FirstSource third quarter 2019 earnings conference call. With me on the call today are Chad Crow, 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 FirstSource website at bldr.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 equivalents in our earnings press release and detailed explanations of non-GAAP financial measures in our Form 8-K filed yesterday, both of which are also available on our website. I will now turn the call over to Chad Crow.
Good morning. Thank you for joining us. I will start on slide two. Our team delivered an impressive performance in the third quarter, building on our year-over-year progress to produce above-market growth, expand margins, and generate outstanding cash flow. I am proud to say that we recorded the 13th straight quarter of year-over-year increases in adjusted EBITDA and achieved an EBITDA margin of 8.1% of sales, our highest quarterly percentage since our 2015 acquisition of ProBuild. Our ongoing strategic investments in market-leading value-added products capacity has provided the targeted growth, margin, and customer value benefits we anticipated. Our operational excellence initiatives also continue to gain momentum and are contributing to our results. Notably, our strong cash flow and working capital management continue to fund our investments, which included an acquisition of three strategic truss manufacturing plants and further pay-down of debt.
We were especially pleased to achieve the low end of our long-term targeted ratio of net debt to adjusted EBITDA of two and a half times as of the end of the quarter. We believe our success is a direct result of our commitment to our strategic initiatives. Our momentum and sales volume during the quarter continued from the strong first half of 2019, supported by an improvement in all of our end markets. For the first nine months of the year, sales volume, excluding commodity deflation, grew by more than 6%. Once again, our value-added product categories led the volume growth, increasing in sales volume by an estimated 9% in the first nine months as we continued to realize the benefit from years of strategic investments. Commodity deflation negatively impacted sales by nearly 13%, which led to an overall decline in reported sales of 7%.
Despite the headwinds, we grew adjusted EBITDA by 8% compared to the same year-to-date period last year, thanks largely to our team's focus on executing our growth strategy that drove a 300-basis point improvement in gross margin percentage. Our operational excellence initiatives continue to have a positive impact on our results. As mentioned on our previous calls, we are executing upon key initiatives with specific action plans in four key areas: enhanced business analytics, pricing management tools, our MyBFS Builder customer portal, and delivery optimization technology. During the first nine months, we saw the benefit of these initiatives, especially with our pricing tool implementation and delivery optimization platform, which has improved our distribution network in terms of speed, uptime, and reliability. At the same time, we have laid the groundwork to enhance efficiency in other areas such as on-time delivery and inventory management, which Peter will discuss in more detail.
We remain on track and expect a benefit of between $14 million and $16 million to our adjusted EBITDA in 2019 from these initiatives. Our market-leading network of value-added off-site component manufacturing facilities has positioned us well to meet the growing demand from home builders for productivity and efficiency in the face of ongoing increases to labor costs and scarcity. In July 2019, we expanded our presence to the Las Vegas and Phoenix markets by purchasing three truss manufacturing facilities. Our ongoing organic investments also continued during the quarter, and we are on track to have two new greenfield truss plants and approximately eight new truss lines in existing plants by year-end. In addition, we are investing in door facility expansions as well as new machinery and systems in a dozen more of our value-added operations.
We will continue to invest in expanding our industry-leading production capacity, sales force, and distribution network. Our commitment to broadening this competitive advantage is what has led to our above-market growth and outstanding track record of performance. I will now turn the call over to Peter, who will share our third quarter financial results in more detail.
Thank you, Chad. Good morning, everyone. I'm especially proud of our team's work in delivering another quarter of improvement in the controllable aspects of our business. We achieved $2 billion in net sales in the third quarter, down 6.5% versus the prior year period. We had one additional sales day in the third quarter of 2019 compared to the prior year quarter, so I will speak to our sales drivers on a sales per day basis for better comparability. Net sales per day declined by 8% due to commodity deflation, which decreased sales by an estimated 17.4%. The commodity headwind masked robust sales volume growth of 9.4%, a rate significantly above the overall U.S. starts market. The largest contributor to this growth was once again our value-added product categories, which increased 11% over the third quarter of 2018, reflecting the ongoing execution of our strategic plan.
Gross margin of $541.1 million increased by $18.4 million or 3.5% over the prior year. Our gross margin percentage increased to its historical high at 27.3%, representing a 260 basis point improvement compared to the same period a year ago. The margin percentage increase was attributable to several factors, including an improved product mix as our team continued to maintain focus on delivering higher-margin, value-added solutions to our customers. Additionally, the decline in the cost of commodities, along with our team's continued focus on pricing discipline, contributed favorably to gross margin. In regards to pricing and commodity costs, as we have discussed on prior calls, market cost inflation causes short-term gross margin percentage compression when prices rise rapidly relative to the short-term pricing commitments we provide customers. We experienced this temporary contraction during the third quarter of 2018. Conversely, gross margin percentage expansion occurs when costs rapidly decline.
This quarter, commodity prices dipped a bit lower before recovering to levels in line with the beginning of the quarter. As a result, we believe the tailwind that we have experienced for most of 2019 has concluded as commodity prices remain stable, which we expect will return gross margin percentages to more normalized levels in the fourth quarter. Our SG&A as a percentage of sales increased by 190 basis points on a year-over-year basis, driven largely by the impact of deflation on sales. In addition, strong volume growth and higher gross margin led to higher variable compensation in the quarter. As we have mentioned in prior quarters, our incentives increase as our sales team achieves higher margins. Accordingly, our strong gross margin percentage gains more than funded the higher commission expenditures in the quarter.
Interest expense for the quarter was $27.8 million compared to $29.1 million in the prior year, a decrease of $1.3 million. Excluding a $3.1 million charge related to a debt financing transaction executed in the third quarter of 2019, interest expense declined by $4.4 million, largely due to lower outstanding debt balances. During the quarter, we issued an additional $75 million in notes that mature in 2027. The net proceeds were used to repay a portion of our 2024 notes. This is another step in prudently managing our balance sheet by extending existing maturities while simultaneously reducing our overall leverage ratio. Adjusted net income for the quarter was $84 million, or $0.72 per diluted share, compared to $77.8 million or $0.67 per diluted share in the third quarter of 2018.
The year-over-year increase of $6.2 million or $0.05 per share was primarily driven by the improved operating results, combined with lower adjusted interest expense. Third quarter EBITDA grew by $5.5 million or 3.5% to $160.3 million, the highest in our history, driven by the growth in gross margin mentioned previously. Turning to slide four, the strength of our business, driven by our national scale and strong local customer relationships, was again evident in the third quarter results as U.S. housing starts improved. Our team grew net sales across our value-added and non-commodity related product categories. Excluding deflation, our lumber and lumber sheet goods product category also achieved solid growth in estimated sales volume. We are committed to the expansion of our component manufacturing network strategically located across the country.
We continue to build upon the strength of our existing network, and as Chad mentioned, we are pleased to have added Sun State Components to the Builders FirstSource family, along with its three additional truss manufacturing facilities, bringing our total to 61. Turning to page five, our third quarter sales volume per day grew over 9% in the single family new construction end market, compared to an increase of 4% in overall U.S. single family starts. Regional strength in parts of the East, an improvement in Texas, as well as the Pacific Northwest, contributed to our outperformance. A common thread throughout all parts of the country is that we grew value-added products across our footprint. Our sales volume in R&R and other end markets increased by 11%, driven by solid home improvement activity in Southern California.
Multifamily sales volume improved by 5.8%, largely due to the timing of projects compared to the prior year. Turning to page six, I'll first point out that we now define free cash flow as cash provided by operating activities less purchases of property, plant, and equipment or CapEx. This quarter, we have updated the metric to exclude acquisitions and other cash investments for better comparability to peers and to more clearly delineate between our discretionary free cash flow and our strategic capital allocation priorities. For the first nine months of 2019, we have generated $282 million in free cash flow, representing well over 100% of adjusted net income.
Although our business typically uses cash in the first half of the year and generates cash in the second half due to seasonal working capital needs, the exceptionally strong cash flow performance so far in 2019 is due to the impact of commodity deflation and our operational excellence initiatives driving working capital improvements. We continue to allocate our capital to strategic priorities, which include growing our value add capacity, funding strategic acquisitions, and further improving our balance sheet to generate shareholder value. We remain on track to invest approximately 25% of our total 2019 capital expenditures in our value-added growth initiatives and expansion of our production capacity. During the third quarter, we funded our acquisition with approximately $34 million in cash. We were especially pleased to make these investments while at the same time preserving ample liquidity and further improving our net leverage ratio.
At quarter end, our net debt to trailing 12-month adjusted EBITDA ratio was 2.5 times. This represented a 1.4 times reduction from the prior year quarter and at the low end of our target range of 2.5 to 3.5 times, improving the strength of our balance sheet and providing capacity and flexibility for future business developments and M&A. Moving to slide seven. The rollout of our operational excellence initiatives is driving greater working capital efficiencies through our disciplined framework designed around systems, tools, and processes that are directly aligned with our cash flow performance objectives. A key catalyst here is that these initiatives are not only a benefit to Builders FirstSource, but also significantly benefit our customers. For example, the implementation of our delivery optimization systems improves the reliability and efficiency of our outbound logistics network while minimizing transport and storage costs.
By ensuring efficiency throughout the distribution process, we improve inventory days through higher turns and reduced cycle times. Our customer also benefits from increased on-time delivery, which in turn drives higher satisfaction rates. Similarly, adoption of our customer portal, MyBFS Builder, is supporting increased online payments, allowing for faster and more efficient cash collections. While this achieves faster cash collections for us, customers also receive the benefit of having 24/7 access to key business information like orders, deliveries, invoices, and statements. The speed, benefit, and convenience of the portal are perfectly aligned with the dual goal of efficient capital management and enhanced value to the customer. Our approach is systematic and plans to achieve these improvements are measurable. Implementation is rooted in changing the process, routines, and tools used across our 400 locations. We have regular progress checks to ensure successful execution and that the improvements are sustainable.
This includes annual targets, monthly follow-ups, training, and corrective action plans as needed. Above all, performance towards achieving the desired results are directly tied to compensation at the local level in order to provide the proper alignment of incentives. Approximately 60% of our locations have working capital improvements this year, and we expect working capital as a percentage of sales to improve by approximately 1.4 percentage points in 2019, contributing to incremental free cash flow. We are demonstrating success at implementing structural changes throughout our organization, consistent with our long-range plans to achieve sustainable cash conversion improvement as we grow net income. Moving to slide eight. Looking forward to our fourth quarter and full year 2019 expectations, we remain confident in our team's ability to execute on market opportunities, mitigate commodity cost dynamics, and deliver on the initiatives within our control.
We expect fourth quarter net sales per day to decrease between 2%-5% over the prior year, driven predominantly by the impact of commodity price deflation of between 7% and 10%. Gross margin is anticipated to be down 50 to 70 basis points versus the fourth quarter of 2018, as we return to a more normalized margin. Fourth quarter adjusted EBITDA is expected to be between $100 million-$110 million, supported by continued focus on cost discipline and efficiency improvements. We expect an effective tax rate in the fourth quarter slightly below our long-term guidance of 24%. For the full year, we anticipate adjusted EBITDA to be in the range of $507 million-$517 million. Capital expenditures are on plan and expected to total approximately 1.5% of full-year sales. Regarding cash taxes, we expect to be a federal cash taxpayer again in the fourth quarter of 2019.
Cash interest and interest expense are both expected to be approximately $100 million. As we complete our systems integration work to support our operational initiatives, we expect one-time costs of $15 million-$20 million for the year. Consistent with our previously discussed definition, we expect our full-year free cash flow to be in the $300 million-$320 million range. Chad will provide an update regarding our strategic priorities and outlook.
Thank you, Peter. As we enter the end of the home buying season, the overall market outlook continues to improve. Home builders are increasingly catering to demands of buyers with a more affordable and right-sized product. Our market-leading investments in value-added products and ongoing growth initiatives enable us to provide productivity solutions to help our customers meet the changing demands of home buyers. In this environment, we are confident that we can continue our positive momentum to generate growth in our fourth quarter sales volume in the mid-single-digit range, led by single-family activity. Moving to Slide nine. Based on our meaningful progress to date against our longer-term targets, we remain confident that our unmatched scale, market diversity, and value-added product leadership provides us with substantial opportunities to generate strong returns in our business.
Our value creation framework begins with capturing incremental benefits from core business growth as the fundamentals of home buyer demand remain intact and starts to continue to move towards historical averages. In addition, customers are accelerating the adoption of our labor-saving, high-efficiency, value-added products, providing significant ongoing opportunities to increase our market share. To meet this demand, we will continue to invest in value-added product facilities. The execution of this plan can be seen in our results with the five additions we are making this year. We see the market opportunity for these higher-margin products only increasing as customers recognize the value these products provide and accelerate their adoption. As we discussed today, our value creation plan also includes a set of operational excellence initiatives that are well underway.
This includes the rollout of our distribution and logistics software, pricing and margin management tools, back-office process efficiencies, and information system enhancements. When fully rolled out across our roughly 400 locations, these initiatives in operational excellence and value-added products are designed to deliver cost benefits and margin expansion. Equally important, we will further differentiate our service levels and strengthen our connectivity and overall value proposition with our customers. The execution of our long-term value creation plan, combined with favorable demand tailwinds, puts us on track to achieve our goal of $200 million-$270 million in incremental EBITDA, representing a 50% increase as compared to the full year 2018, as housing starts reach historical averages. This translates to EPS between $3 and $3.50.
Our focus on cash will remain a key to delivering shareholder value, and we intend to sustain greater than 85% conversion of our adjusted net income to free cash flow. The substantial cash we generate will be used to fund both our high-return growth investments and to further improve our financial flexibility. Our national footprint, unmatched manufacturing scale, and exceptional sales force provides us with a platform to capture a larger share of the growth tailwinds in the coming quarters and years. Together with our ongoing investments in operational excellence and value-added capabilities, these strategic initiatives continue to give me confidence that we will achieve our goals. More broadly, I am confident that our disciplined strategic execution and implementation of these systems, tools, and processes has created a durable platform that will allow us to consistently create value for our customers and shareholders.
I would especially like to thank our 15,000 team members across the country for their hard work and the part they each played in achieving our record profitability. Operator, we can now open the call for Q&A.
Thank you very much. Ladies and gentlemen, at this time, we would like to open the floor for questions. If you would like to ask a question, you may press star one on your telephone keypads now. Questions will be taken in the order in which they are received. Again, if you would like to ask a question, please press star one on your telephone keypad now. Our first question will come from Trey Grooms, Stephens Inc.
Hey, good morning. Congrats on a good quarter.
Thank you. Good morning.
The outlook here for the 4Q, also equally impressive. In looking at the gross margin guide that you've given us here, 26.4%-26.6%, I think, Peter, you mentioned that a lot of the tailwind from commodity price deflation has concluded, and you expect it to normalize in the 4Q. Is this 26.4%-26.6%, I'm sure it's a lot closer, but is that the normalized gross margin we should be targeting there? Is there anything else going in there that might be helping it out?
Well, we certainly have seen very stable commodity prices over the last few quarters, it'd be disingenuous to talk about the near-term impact of deflation as it relates to our pricing commitments. What we have seen that I think is important to note is this sense that there's value in the delivery of the product in the commodity side, that is paid off with slightly higher margins as the value has declined. I think there's been some stickiness to a little bit of those higher margins, probably a bit more than we anticipated. We think we'll still stay above 26%, I think there's room for that to drift down a little bit as we go into the upcoming year and years. We certainly feel good about Q4.
I'll just add, Trey, that we've seen a little bit better expected results in our pricing initiatives that are part of the Operational Excellence Initiative. That's been really good to see as well, and it is contributing to some of that.
Great. Okay. Just for clarity, you changed how you calculate free cash flow, I think. You made a mention of that. The free cash flow that you're guiding to for full year, the $300 million-$320 million, how does that compare to the prior goals that you had set, maybe in the, I think it was $180 million-$210 million? How does that compare relative to the prior number?
Yeah.
Is it a combination, I guess? How does the calculation compare? Is it the same or is it different?
It is clearly an increase. When we talked about it last time, we were around that 200 range, accounting for the money that we were anticipating, or that we had announced we were going to invest in Sun State Components. There was $34 million of M&A plus the 200. We were about 234. Pretty substantial increase, obviously, from that point. We've continued to see strong results in our working capital initiative, and we've not seen a bit of the recovery in the pricing of lumber commodities that we thought would happen. I think for the year, we're absolutely calling up cash.
Got it. Okay. That's kind of the comparable number, the $234, roughly, is kind of the comparable number to the $3-$320?
Yes.
Okay, perfect. Wow, that's pretty awesome. Looking at last thing from me before I pass it on. You've got the leverage now at 2.5 times.
the low end of the range. Should we expect maybe a pickup in M&A since you're at the low end?
pushing the accelerator a little harder in greenfields? Maybe the outlook for greenfields in 2020 is kind of a lead on to that too.
I'll answer the M&A side. There's a lot of opportunities we're seeing out there right now. I guess the answer would be yes, it does clearly give us more financial flexibility to do M&A. We are still going to be very disciplined about it, and make sure that we do deals that make sense strategically from a long-term perspective. Yeah, you could see a pickup. Like I said, there are a lot of deals out there. We're looking at some. We'll see how they shake out. We're not going to go crazy. We're going to be disciplined about what we're doing. It's nice to have that flexibility again.
And any-
And as far as the-
Sorry.
As far as the greenfield, we're looking at two to three greenfields.
for next year that we think will come online. In addition, we'll do, of course, our continued investments in expanding and enhancing the capacity of existing facilities.
Got it. All right. Well, thanks for taking my questions. I'll pass it on, and good luck with the current quarter.
Great.
Thank you.
Thanks, Trey.
Thanks, Trey.
Thank you. Our next question will come from Matthew Bouley, Barclays.
Good morning. Thank you for taking my questions, and congrats again on the quarter. I wanted to ask a bit about the pricing tools. Obviously, lumber prices perhaps creeping back a bit, I guess, around the better single-family market. Can you kind of discuss what you've seen over the past few weeks with lumber bottoming and moving higher a bit, if that kind of provides a bit of a test? If you guys can kind of point to any tangible improvements you've seen as a result of your pricing initiatives, perhaps relative to past years, reflecting these efforts? Thank you.
Yeah. Lumber has moved a little bit. It hasn't moved significantly. Most of the pricing initiatives we've done to date are really focused more outside of the lumber products. Really what we're doing there is just creating a lot more structure on a market level basis and more of a market level pricing concept and making it easier on our operators at the local level to do pricing more accurately and quicker, and just taking some of the manual process out of it. No, I wouldn't say the little bump we've seen in lumber has been, as you described, a test on our initiatives, because most of those are focused on the categories outside of lumber to date.
Okay. Got it. Thank you for clarifying that. I just wanted to ask about the Q4 guide. Just looking at the revenues, I guess number one, I didn't hear if there's anything we need to be aware of around selling days there. Just looking at the implied volume numbers relative to the third quarter, if I'm doing the math right, it would seem you're guiding to a bit of a deceleration, and correct me if I'm wrong there. Did you see anything in October that's driving that, or are you guys just kind of layering in some conservatism? Any detail there? Thank you.
Yeah. The fourth quarter forecast is always tricky given the weather patterns, the normal seasonality. It's a challenging quarter as teams really focus on preparing themselves for the lean months and preparing for the upcoming year. We will have one less selling day in the quarter, so that's a factor as well. We certainly feel good about the performance coming out of the fourth quarter. We're certainly not pessimistic at this stage. We are seeing the expected increases as the customers are seeing healthy orders coming in. We feel good about that and feel pretty optimistic about how things are shaping up for both fourth quarter, but also for 2020.
All right. Got it. Thanks a bunch, and congrats again on the quarter.
Thank you.
Thank you very much. Our next question will come from Michael Dahl, RBC Capital Markets.
Morning. Thanks for taking my questions.
Good morning, Mike.
Wanted to ask a question about OSB. OSB prices have started to move higher, and I think the industry's taken off about 10% capacity over the recent weeks. There's an expectation from some of the analysts covering those stocks that you're going to see a material move higher in OSB pricing. Can you remind us what percentage of your business would OSB represent, either in the lumber and sheet goods category, or also if it's part of manufactured products, and just any color around what you're seeing, hearing, and how you think you can manage that?
Sure. I can baseline it and let Chad maybe talk about his sense of the market. The commodities, broadly speaking, represents right around 40%, just about the same as the value add of our total sales. Within that category, OSB is roughly 30%, so overall, maybe 12% of sales. OSB is not a substantial part of the manufactured components. Obviously lumber is, but not a substantial part. It only comes into play when we've got wall panels with applied sheathing. Yeah. I'll just comment on some of the curtailments that have been announced. Long term, as we've talked about over the years, is we prefer higher prices. If some of these curtailments does lift prices, that's a good thing. As you know, we will see a little bit of margin compression in the interim, but longer term, that's a good thing for us.
We view some of the curtailments more as taking off some of the incremental capacity that's come online the last year or two. Our view is, yes, it will help firm prices. I think a lot of it is still going to depend on the demand that we see, especially going into the spring building season next year. In my mind, curtailment is a good thing because we prefer the higher prices. As far as managing through it, I'm not worried about that. My gosh, look what we managed through back in 2018, and I think we did an outstanding job doing that. As far as managing through the fluctuations, that doesn't concern me.
Okay. That's helpful color. Thanks for that. I guess maybe just to follow on, if we're thinking out into 2020, and obviously the results this year have been excellent. Is there a way to ballpark from the 2019 guide, how much of that was, I don't want to say totally non-recurring benefits, but effectively just the benefits of the favorable price costs? From a baseline standpoint, it seems like volume growth should be sufficient to offset whatever you lose there. Just any preliminary thoughts on how you're thinking about EBITDA dollar growth potential next year, given you likely lose some of that tailwind from price cost?
Yeah. No question. You're absolutely correct that we received some of the benefits from the tailwind as the deflation hit. We were pretty open about that as we went through the year. There'll be some of that next year. We agree growth will be obviously a tailwind for us next year. We feel good about both the markets and our competitive position, so I think those are positives. I'm not ready to give a specific guide on that, but we do anticipate having that for our next call as we roll out our 2020 numbers for the Q4 call. Absolutely intend to break that down for you.
Okay. Thanks for that.
Thank you. Our next question will come from Alex Rygiel, B. Riley FBR.
Thank you. Good morning. Your organic growth in the quarter was very strong, particularly with regards to your value-added products. The home builders are seeing incredible demand over the last three months and in the month of October. Can you talk a little bit about your ability to keep up with their demand in the coming months? Talk a little bit about your ability to add labor and maybe highlight what your utilization rate of your facilities is right now.
Keeping up with demand, labor is a challenge. It has been for years, especially in areas. Drivers has gotten a little better. Still, yard personnel and folks working in our manufacturing facilities, labor's tough. I'm confident that our facilities can handle the demand, whatever the builders throw at us. We could struggle at times with employees, but we've got a lot of temp agencies that we use, and we call on them when we need to. From my standpoint, bring on the demand because we've got the footprint to handle it. I'm not too worried about our capacity.
That's great. As you reengage in M&A, can you comment on seller price expectations these days and what kind of competition you're seeing out there?
Some of the deals we look at are auctions. Some of them aren't. Some of them come from relationships that we've kind of been cultivating over the years. Those are our preferred. You're not in the bidding process. Overall, I would say sellers' expectations are pretty much in line with what buyers want to pay these days. I would say over the last couple of years, they seem to have come down a little bit, the sellers' expectations. It's, in my opinion, a pretty good time to be a buyer out there.
Thank you.
Thank you. Our next question will come from Keith Hughes, SunTrust.
Thank you. Some of the commentary on the call here on the good order growth coming from the builders, a fair amount of that's coming towards the low end of the market. I would assume that would be a positive for you on giving your push into truss manufacturing, but would love to kind of hear your opinion on that and any other impacts that would have, either positive or negative, on your business.
Well, you're right. A lot of the incremental demand we're seeing is in some smaller homes and really to meet some of the affordability issues that's facing home buyers. My opinion is always the more houses we build, the better. We're a distribution company to a large degree, we need volume. My belief is, if we're ever going to get back to that normal $1 million-$1.1 million in single-family houses, you've got to have a higher contribution from the lower-end homes. To me, it's just all about let's build homes. To your comment on it playing to our advantage, yes, we obviously have a very large manufacturing footprint, and when you're building some of these common starter homes, a lot of the, especially the national builders, will use repeat home designs.
We can be very efficient in our truss plants when we're building those houses. There's just not as many changes to the truss line setup. Yes, there are some incremental efficiencies for us there. Clearly, as homes get smaller, you're losing other parts of the home. You may have a few less windows, a few less doors, but again, net, it's all about building more homes for us.
Okay. Thank you.
Thank you.
Thank you. Our next question will come from Trey Morrish, Evercore.
Thanks, guys. I just want to add my great job on the quarter.
Thank you.
I wanted to talk about the value-added products a little bit. You highlight how they're definitely a tailwind and definitely are something that seems like builders are looking to more and more. Could you just talk about how you think builders are going to continue to shift more towards the use of those value-added products over time, given labor constraints and given your abilities to continue to make more as you either acquire or build out greenfield locations for those?
I look at it's a cyclical business, right? There's times when labor's tight, and there's times when housing slows and labor is readily available. This has been the longest streak I can ever remember of tight labor, and there's many reasons for that, but I just don't see it solving itself anytime soon. I think as the years tick by, the builders are starting to see that as well. A big driver for them is the labor shortage, the cost of framing labor, and they're looking for ways to mitigate that and improve their cycle times, especially the national builders. They're under earnings pressure just like every other public company out there. They're continually looking for ways to build houses quicker and more efficiently. In my opinion, that's what's driven a lot of them to the product.
History has also proven that as they switch to these products, very seldom will they switch away from it. They realize the benefits and the cycle time and the cost savings. It's just overall an environment that's pushing more and more builders in that direction.
Sure. Do you see anything that would accelerate that move to more value-added products? Do you think it's going to be more of a gradual shift in that direction?
Well, typically it's been a slow-to-change industry. My gut would say it's going to be gradual. Now, if we see a really big surge in housing demand, for example, next year, that could push more and more builders to that because obviously framing labor would become even more scarce. In general, I would say gradual, barring some unexpected increase in demand.
Sure. Just thinking about your volume growth that you've done this year. Clearly, very well in a challenging housing environment, to say the least. Just thinking out to next year, is there any reason to think why, in a better housing market, your volume improvement should be lower than what you've done so far this year?
No, everything else being equal, I wouldn't anticipate it changing significantly. I'm a pretty conservative guy, so our volume gains have been pretty damn impressive this year. I'm always a little hesitant to say we're going to keep doing that. Generally speaking, no. If everything else stays the same and demand is better than expected next year, yeah, I think it's certainly possible that we can hang on to those volume gains.
All right. Thanks very much.
Thank you. Our next question will come from Megan McGrath, Buckingham Research.
Thanks. Good morning. I wanted to follow up on the conversation around lumber prices, in the sense of, if we think about a time when that commodity deflation reverses or at least stabilizes and we get some top-line revenue growth. How do we think about two things? Your ability to sort of get, or for us to see more clearly, SG&A leverage from your operational initiatives. As well as you mentioned cash flow benefiting from the lower lumber prices. How do you feel about your ability to kind of continue to generate strong cash flow, if and when that lumber reverses?
Yeah. The thinking around SG&A, we certainly do expect to get SG&A leverage as the sales increase. You saw us delever this year. We generally think about our SG&A as being 70% variable, so some leverage associated with that. We do have internal initiatives that relate to the operational excellence initiatives. We will call those out to give you a chance to get a clearer understanding about what we're up to. Certainly, we'll see that in there. As far as the overall growth of the business, we certainly think that the increases in lumber and commodities, given where prices are more likely than decreases from here. We think that our ability to grow the business and to leverage off of those is consistent.
Obviously, we've gotten through an up and a down cycle in commodities, so we feel like, as Chad mentioned, feel very good about our ability to manage through it and to be able to leverage that both directions. I am not sure if I hit both of your questions effectively.
Any thoughts on cash flow?
Yeah, I think the cash flow side of it is, there's no question that as the values of commodities increase, well, for the value of both lumber and OSB, we will see correlating increases in the values of AR inventory and AP on our side. No question that a fair share of the benefit, both at the end of last year and through the first half of this year from a cash flow perspective, has been because of that deflation. We'll absolutely be investing cash as we go the other direction. That said, there is a component of this that really is attributable to, I would say, enhanced focus and discipline, enhanced processes and procedures internally. We feel good about holding onto that. Yeah, I'd be crazy to tell you it wasn't going to cost us some money if things reinflate.
Right. Okay. Just a quick follow-up on the repair, remodel, and multifamily segments. You pointed to some improvements in, I think, Southern California for repair, remodel, and it sounded like maybe some pent-up demand in multifamily running through. Any more color on that, and whether that was sort of one timing in the quarter, or if you think it'll last another quarter or two, that would be helpful.
Yeah. Well, that's a great question. I think that when it comes to the R&R component of R&R and other, we've seen some stabilizing. We've seen some, while still down, more stable on a year-over-year comp basis in the Midwest, for example.
We've seen some stabilization and even some modest improvement in Alaska and some improvement in Southern California. The area that's probably the more volatile component is the other. We do a fair amount of commercial and industrial. As you called out, we have a multifamily business that's doing well. That other is a lot of project-driven business. It's been very good to us this quarter. There's some parts of the country that have competed very well, taking advantage of stumbled competitors. I think we feel good about that. For the quarter, it's obviously a win. I don't think I'd want to extrapolate that forward, but we do feel good about at least lapping the negatives from the prior year in terms of the impact of tariffs and really the hard turn in that Southern California market.
Got it. Thank you very much.
Thank you. Our next question will come from Matt McCall, Seaport Global Securities.
Thanks. Good morning, everybody.
Hey, Matt.
I just want to better understand a couple of things. If I try to look at volume by product category, I think you said value add overall was up 11%. I know I think there were 17 points of commodity pressure. If I just look at the, I'm trying to better understand the impact on manufactured products from the commodity moves. I guess I'll tell you the way I thought about it is, did you see revenue pressure, but maybe there's a profitability benefit from a lower input cost? Am I thinking about the directional nature of those two items the right way?
I'm not entirely sure I understood. I think what I can say is that we did see growth both in volume and in margins.
Certainly, the unadjusted growth for manufactured components is less because of the substantial headwind that we've seen from commodities. Manufactured products grew solidly in the double digits. Some of the other value add grew, I would say, high singles to get to that average of about 11% in the total value add component. Did that help?
Yeah, it helps. I'm just trying to make sure I don't know what % of that $360 million impacted your lumber and lumber sheet goods versus manufactured products. Maybe I should, but I don't. Have you ever broken that out or is it easy to calculate?
I don't think we have.
Okay. All right. No, you don't have to. That's fine, Peter. Yeah. The next question, I want to go back to technology. I definitely understand the benefits that you discussed, but can you put any numbers to that? Is there a way to look at market share gain, margin impact? You talked about cash collection and some of the improvements there. Can you put any numbers to that and maybe quantify any benefit that you're seeing? What would be some of the expected benefits from a numbers perspective as we move out into 2020?
A couple of factors. I guess if you look at our total working capital metrics, we've got some pretty substantial improvements. There are two components to that, obviously, and two different drivers, operational versus deflation. Where you will see the benefit is in reduced inventory. You'll see it in lower DIO or days inventory on hand, lower DSO and days sales on hand in the AR metric. You'd see it in a lower SG&A as a % of sales as we go through the aspect of the efficiency generated by utilizing online tools, having automated interfaces that allow us to be more efficient from the administrative side. There's an efficiency also associated with any time you're applying cash and trying to work with a customer, you're utilizing labor resources to do that.
If the customer is doing it themselves, obviously it's always right because they're doing it themselves. We haven't called out a dollar amount. We're planning to roll that into the operational excellence update. As we get into the full year, we'll update the full year, but we'll definitely call that out. I think it's fair to say that we're not looking at doing this as a labor cut basis for restructuring like some companies do. I think what we're really focused on is filling in for attrition and really looking at how do we continue to grow the business and leveraging the resources we already have on hand, because it's hard to get good people, and we want to make sure we take advantage of the ones we have on staff.
Yeah, I'll just add real quick, some of the operational excellence initiatives are easier to measure than others. Like customer engagement on our website, kind of hard to pin down a dollar benefit to that. Some of them are a little easier. The margin expansion and the logistics initiatives, those are much more tangible and easier to measure. We've guided the $14 million-$16 million of benefit
In 2019, I think we have a chance to do a little better than that. If it helps, that's a pretty even split between margin and SG&A right now, those savings. The SG&A portion really shows itself as more efficient yard labor and more efficient running of our trucks and less fuel costs. If that helps, that's a pretty even split between margin and SG&A on those two items.
You'll give an update on the 2020 expectations next call?
Yes.
Okay, thank you all.
Thank you.
Thank you. Our next question will come from John Lovallo, Stifel.
Thank you. Good morning. Mike, congratulations as well. Great execution.
Thanks, John.
Good morning. Thanks, John.
Could you remind us of your long-term goal on the percentage value add, number 1, and does the timing to get there change with some of these acquisitions adding to the greenfield strategy? Does that long-term goal maybe rise a little bit from your original thinking, seeing what the labor shortage and the success and seemingly the demand pull you're getting from your customers? Thank you.
Yeah. Well, from my standpoint, the higher our value add mix is, the better. Clearly, the acquisitions we're making could help get us there sooner. Should help get us there sooner. I guess our nearer-term goal is more of a 50/50 mix between lumber and our distributed product and then value-added product. I certainly wouldn't be heartbroken if we hit that number and continue to blow past it. It's clearly the most profitable part of our business. I think it helps differentiate our company versus some of our peers. Yeah, the near term's 50, but longer term, if we can get past that, I'll certainly shoot for it.
I think it's worth pointing out that this quarter, our value add business is a greater % of our total sales than our commodities.
Got it.
Important.
Thanks for that, Peter. Maybe on a high level, how should we think, maybe a reflection several years post ProBuild. It seems from my seat it was successful. I know it's a lot of work. How do we think about where we are in the housing cycle, where your balance sheet is, and what your appetite may or may not be to entertain another big deal in the next several years? Thank you.
Always open to entertaining a larger deal. Maybe something could happen if it was a combination of debt and equity, depending on the size of the deal. Maybe an all-cash deal. We never try to be closed-minded. We're certainly open to opportunities that make sense and are strategic from a long-term perspective. Right now, I don't see any of those on the near-term horizon. Most of the deals we're seeing now are smaller to mid-size deals, but could fit in nicely from a strategic standpoint as well.
Okay, great. Congrats. Good luck Q4 and beyond. Thank you.
Thank you, sir.
Thank you.
Thank you. Our last question will come from Kurt Yinger, D.A. Davidson.
Yes, good morning, everyone, and appreciate all the details. I just wanted to go back to volumes and maybe take it in a bit of a different direction. Obviously, really positive trends on the value add side, but the other categories have grown pretty well, too. I'm wondering whether you think you can be a share taker going forward in those non-value add categories, and if so, what do you think is really separating kind of Builders FirstSource versus your competitors?
Yes, we can be a share taker in other categories, but to me, a lot of it boils down to pricing and margin expectations and return on investment. We've always said over the years, you can take all the share you want if you're prepared to drop your drawers and lower your prices. We tend not to do that. We try to be very thoughtful about how we allocate our capital and return on investment. Yes, if the returns are adequate, we're more than happy to grow share there as well. I'll call it the distributed side of our business is the most competitive. Clearly that results in lower margins on average.
Most of our focus over the years has been on the value add side of the business, better margins, better ROIC, and that's where we will continue to focus our efforts.
There's no question that the portfolio that we're able to offer based on our scale and our product breadth has been mutually beneficial. As we do a really good job with our customers, and we partner with them on value add, really makes a lot of sense, just ease of doing business to work with us on the other products that they purchase as well, and as long as it's a fair price. It's been a fun way for us to continue to grow the business.
Great. Thanks for the color. Good luck in the fourth quarter.
Thank you.
Thank you. At this time, there appear to be no further questions. Mr. Crow, I will turn the call back over to you for any closing remarks.
Yeah. Thank you again for joining our call today, and we look forward to updating you on our fourth quarter and our full-year results in February. If you have any follow-up questions in the meantime, please don't hesitate to reach out to Binit or Peter. Thank you.
Thank you very much. Ladies and gentlemen, at this time, this now concludes our conference. You may disconnect your phone lines and have a great rest of the week. Thank you.