Good morning. Welcome to the Builders FirstSource Fourth Quarter and Full Year 2018 Earnings Conference. Today's call is being recorded and will be archived at www.bldr.com. Now it's my pleasure to introduce Mr. Binit Sanghvi, Vice President, Investor Relations. Please go ahead.
Thank you, Laurie. Good morning. Welcome to the Builders FirstSource Fourth Quarter and Full Year 2018 earnings conference call. With me today are Chad Crow, Chief Executive Officer, and Peter Jackson, Chief Financial Officer. A copy of our slide presentation referenced on this call is available on the Investor Relations section of the Builders FirstSource website at www.bldr.com. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. Instructions will follow at that time. Any reproduction of this call in whole or in part is not permitted without prior written consent of Builders FirstSource. As a reminder, this conference call is being recorded today, March 1st, 2019. Builders FirstSource issued a press release after the market closed yesterday. If you do not have a copy, you can find it on our website.
Before we begin, I would like to remind you 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. Detailed explanations of non-GAAP financial measures in our Form 8-K filed yesterday, both of which are available on our website. At this time, it is my pleasure to turn the call over to Mr. Chad Crow.
Thank you, Binit, and good morning, everyone. I appreciate everyone taking the time to join our call today. I would like to share with you an update on our 2018 financial highlights and strategic achievements. I will turn the call over to Peter, who will discuss our Q4 financial results in more detail. I will then finish with an update on our strategic priorities and outlook. Starting on slide two, we completed a year of very strong financial performance and achieved key milestones of value creation despite a moderating growth environment and a volatile commodity market. In 2018, we again showed the agility and resilience of our exceptional team, platform, and strategy. Net sales in 2018 grew by almost 10%, and EBITDA grew by almost 20% to a record annual $502 million. Earnings per share increased by nearly 50%.
Value-added sales grew by an impressive 10% as we continued to invest in our strategic growth capacity. Our dedicated team accomplished these results while at the same time executing on our working capital initiatives, generating a record $186 million in free cash flow for the full year 2018. Using that strong cash flow generation, we achieved our leverage target announced at the time of the transformative ProBuild acquisition in 2015. Turning to slide three, I would like to spend a few minutes highlighting a few of our strategic achievements in 2018. First, we continue to realize the growth and margin expansion benefits of our strategic investments in value-added products capacity by helping our customers solve challenges like increasing costs, lack of labor, and waste management. These investments are driving higher-margin sales as we continue to grow our industry-leading manufacturing network through new plants, automation, new machinery, and system upgrades.
Since 2016, we have opened eight state-of-the-art truss and millwork manufacturing facilities. As these facilities mature, sales will continue to grow, enabling us to capture share of the expanding off-site fabrication market as home builders look for solutions to overcome their labor and cost challenges. We also continue to make progress on our operational excellence initiatives. These best practices are being implemented throughout the organization to make Builders FirstSource more agile and more responsive. Initiatives underway include enhanced business analytics, pricing management tools, our MyBFSBuilder customer portal, and digital safety, among others. I will specifically highlight our delivery optimization success a little later in the call, which is already posting tangible benefits, furthering the competitive advantage of our efficient distribution network. We once again delivered on our commitment to generate strong free cash flow to fund our long-term investments while restoring balance sheet financial flexibility.
We funded $101 million in capital investments, including further expansion of our industry-leading value-added production capacity, refreshing our fleet of rolling stock, and upgrading our asset base. At the same time, we reduced our leverage to 3.1 times as of December 31st, 2018, a reduction of 1.1 times compared to the prior year-end. Lastly, hiring, training, and retaining the best people continues to be a top priority. We invested in the addition of 160 new sales team members in 2018. We also introduced training tools and processes to systematically drive and enable the productivity of our high-caliber sales culture throughout the organization. We are only as strong as our 15,000 talented team members, and we remain committed to growing and developing future leaders throughout the organization. I will now turn the call over to Peter, who will review the fourth quarter financial results in more detail.
Thanks, Chad. Good morning, everyone. As a reminder, we have included adjusted figures to normalize for one-time integration and other costs. Please also note that we had one more day of sales in the fourth quarter of 2018 than the prior year, so I will speak to our results on a sales per day basis. We reported net sales of $1.8 billion, a 0.5% increase compared to the fourth quarter of 2017, including commodity deflation of 2.8% and an estimated 3.3% from sales unit volume growth. Our value-add products increased 6.8%, led by a particularly notable 9.1% growth in manufactured products. Gross margin was $492.8 million in the fourth quarter of 2018, increasing by $61.6 million, or 14.3% over the prior year.
We recorded our highest quarterly gross margin percentage ever at 27.1%, up approximately 290 basis points from the fourth quarter of 2017, and a sequential improvement of 240 basis points compared to the third quarter of 2018. Commodity prices declined sharply again in the fourth quarter of 2018, continuing the fall that began in June. Framing lumber and sheet good prices declined 39% and 32% respectively, compared to the beginning of the third quarter. As a result, our gross margin percentage improved as costs declined relative to our customer pricing agreements. Our team again demonstrated its ability to manage through commodity price volatility and at the same time, maintain a consistent focus on delivering high-quality, value-added solutions to our customers.
As we have discussed on prior calls, commodity inflation causes short-term gross margin percentage compression when prices rapidly rise and margin percentage expansion when prices rapidly decline relative to the short-term pricing commitments we provide our customers. Our SG&A as a percentage of sales increased by 160 basis points on a year-over-year basis. This increase was primarily due to increased commissions and incentives related to our particularly strong and highly profitable growth in the fourth quarter. Our outsized gross margins led to higher commissions expenditures in the quarter. Adjusted interest expense for the quarter was $26.6 million, compared to $33.2 million in the prior year, a decline of $6.6 million.
The reduction was largely the result of refinancing transactions the company executed in 2017 as part of a disciplined capital management plan, as well as our ongoing debt reduction, slightly offset by a rising interest rate environment. Adjusted net income for the quarter was $53.1 million, or $0.46 per diluted share, compared to $46.6 million or $0.40 per diluted share in the fourth quarter of 2017. The year-over-year increase of $6.5 million, or 14%, was primarily driven by improved operating results combined with lower interest expense. Fourth quarter EBITDA grew by $28.1 million, or 29% to $125 million. The year-over-year improvement was largely driven by our strong sales growth, particularly in the value-added product categories, expanded gross margin from commodity price deflation.
As mentioned, the outsized benefit to gross margin from the rapid deflation will diminish over time as commodity prices stabilize and gross margin percentages return to a more normalized level. Turning to slide six, our ongoing strategy to invest in manufacturing capacity once again delivered results in the fourth quarter. We grew value-added products by more than double the market rate. Our unrivaled platform provides us significant ongoing opportunities to increase both our overall market share and the penetration of higher-margin products. In addition, we are committed to continuing the expansion of our current network of 58 manufacturing facilities strategically located across the country. Given the ongoing challenges faced by our customers, the demand for our labor-saving products continues to grow and provides us with expanding opportunities for profitable growth.
Our 2019 plans to expand our manufacturing and value-added capacity includes new truss and millwork plants, new truss lines in existing plants, new door machines, new machinery, and new systems impacting dozens of markets and locations. In total, we expect to invest nearly one-fourth of our total 2019 capital expenditures in our value-add growth initiatives. Turning to page seven, our fourth quarter sales unit volume per day grew an estimated 4.5% in the single family new construction end market, outgrowing single-family starts growth. Our sales volume to R&R and other end markets grew by 1.1%, somewhat muted by the slowdown in the Midwest, where much of the economy is driven by the ag industry, which is being impacted by the trade dispute with China. Multifamily declined about 1.8% as expected.
Turning to page eight, total liquidity as of December 31st, 2018, was an ample $595.5 million, consisting of net borrowing availability under our revolving credit facility and cash on hand. Capitalizing on market opportunities and our financial flexibility, we executed a series of open market purchases of our 2024 notes, totaling $53.6 million in the fourth quarter of 2018. In February of 2019, we repurchased an additional $20.4 million in aggregate principal amount of the same 2024 notes. Our net debt to EBITDA ratio as of December 31st, 2018, was approximately half of what it was at the end of 2015, only three years ago, after our strategic acquisition of ProBuild.
This is an important milestone for us. We are proud of the exceptional work our team has done to integrate a transformative acquisition, execute to deliver the synergy targets, and ultimately deliver on the promise to delever our balance sheet. Moving to slide nine, our cash generation was again driven by strong EBITDA growth and our team's focus on working capital conversion execution in the fourth quarter. The $186 million of free cash flow generated for the full year represents an all-time record for our company after funding for $101 million in capital investments. Our current assets are covering an increasingly larger portion of funded debt, reflecting our steadily improving financial stability. As we look forward to 2019, we have a high level of confidence in our team's ability to execute on the initiatives within our control.
Let me provide some color on what we see for our first quarter of 2019. We will have one less selling day in the first quarter of 2019 versus the prior year, so our guidance will be provided on a sales per day basis. We expect commodity price inflation to negatively impact our sales in the range of 6%-8% in the first quarter. As a result, despite expected increases in unit volumes, we expect our first quarter sales per day to be down by a low single-digit percentage as compared to the first quarter of 2018. We expect gross margin percentages to be down sequentially from the fourth quarter of 2018 as a portion of the benefit derived from the rapidly declining commodity costs begins to recede.
As compared to the gross margin percentage in the first quarter of 2018, we expect an improvement in the range of 180-200 basis points. As a result, we expect first quarter EBITDA to grow at a mid to high single-digit percentage as compared to the first quarter of 2018. As we have begun 2019, the macroeconomic environment and fundamental demand factors all remain supportive of growth in single-family starts and the housing market generally. Recognizing the uncertainty in the new housing market and the highly volatile commodity prices, we will at this point refrain from providing detailed full-year guidance. We remain confident in the industry and in our self-driven performance. We expect our operational excellence initiatives to contribute between $14 million and $16 million in our 2019 EBITDA. We will continue to invest in our business through capital expenditures at approximately 1.5% of sale.
Regarding cash taxes, we expect to fully utilize our NOL tax asset and become a federal cash taxpayer again in the second half of the year. We expect an effective tax rate of approximately 25% for the full year. Cash interest and interest expense are both expected to be in the range of $95 million-$100 million in 2019. As we continue our systems integration work to support our operational initiatives, we expect one-time related costs of about $15 million-$20 million for the year. As a result, we expect to generate $180 million-$210 million in free cash flow for the full year of 2019. I will now turn the call back over to Chad to provide an update regarding our strategic priorities and outlook.
Thank you, Peter. Moving to Slide 11. Although the housing market and starts growth have moderated over the last few quarters, we remain confident in the fundamental underpinning of home builder demand and expect that single-family housing starts will continue to move towards the 1.1 million historical average over the next several years. As mentioned, we continue to develop our sales force and invest further in our manufacturing and value-added facility expansion initiatives. These growth platforms provide us significant ongoing opportunities to increase our market share and increase the penetration of our higher-margin products. In addition to capturing market growth, the growth in our value-added product sales and our operational excellence initiatives underway are expected to generate an additional $100 million of profitability in the coming years.
Our plan remains intact to generate EBITDA approximately 50% higher than our 2018 full-year figure of $502 million, or roughly $750 million as we reach historic norms. We have revised our cash flow targets to better reflect the cash culture we are building. Our expectation is that over time, we will achieve greater than 85% conversion of our adjusted net income to free cash flow. The cash generated will be used to fund strategic growth investments and to further improve our financial flexibility. Turning to Slide 12. We detail our specific growth initiatives expected relative to the 2018 performance. Our core business strengths, including our national footprint, unmatched scale and manufacturing capability, and exceptional sales force, provides us with a platform well-positioned to capitalize on the continuing opportunities we see for core growth in the residential housing market.
We expect to generate an incremental $130 million-$160 million in EBITDA compared to 2018 as housing starts to normalize. In addition to this core growth, we will continue to expand our national manufacturing footprint and capabilities to grow our higher-margin value-added products faster than the overall market. Our plans currently call for investing in approximately 20 new facilities by expanding our nationwide footprint to serve a number of locations where we see great opportunities to serve market needs with our customers. Our plan includes a set of operational excellence efficiency initiatives underway, including investment such as distribution and logistics software, which I will discuss in more detail on the next slide, as well as pricing and margin management tools, back-office process efficiencies, and information system enhancements that are expected to contribute between $65 million and $75 million in incremental annual EBITDA.
These projects, when rolled out across our 400 locations, are designed to deliver significant cost benefits and margin expansion opportunities. They will further differentiate our service levels, strengthen our connectivity with our customers, and provide economic and strategic value that is unrivaled by our smaller competitors. These initiatives are well-defined and well within our control. We remain confident that when scaled, they will generate the returns we have targeted. Moving to slide 13. Our dispatch and delivery optimization initiatives have now been rolled out to approximately 140 locations. The goal is to systematically drive best-in-class operational efficiency and customer service. Logistics optimization includes the use of GPS technology to allow for predictive maintenance, driver performance monitoring, route optimization, centralized dispatch, and more precise management of vehicle disposition and procurement. We have already seen an improvement in driver productivity, fuel cost, and safety.
Sales and operational alignment centers around what we call the electronic delivery board. The enhanced reporting has reduced paperwork and allowed our sales team to easily understand the status of all orders, improving accuracy and efficiency. For example, we have seen a reduction in delivery expense and improvement in sales per FTE where fully adopted. The customer collaboration tools provide the delivery status and job site photos to be automatically uploaded to our online portal, MyBFSBuilder, so that sales, dispatch, and the customers can collaborate online. This has already shown to improve construction times through reduced hot shots and product returns and has also improved customer satisfaction. By the end of 2019, we expect to roll the system out to over 250 locations that make up more than 75% of our sales.
In 2018, we delivered profitability and on a longstanding strategic priority to restore financial flexibility, marking the completion of our successful integration of ProBuild. At the same time, we continued to invest in building a more durable value-added solutions platform that has demonstrated growth despite a moderating end-market environment. The ongoing rollout of our operational excellence initiatives also continued creating an even more agile and responsive Builders FirstSource. Despite the commodity price volatility, we demonstrated the strength and value of our differentiated platform across our national footprint to produce solid growth. While the economy and key fundamental demand factors remain supportive of housing growth going forward, visibility into 2019 at present is challenging.
The timing and extent of the growth in single-family housing starts, in our opinion, will depend on the continued low unemployment, stable interest rates, and home builders adjusting to the evolving profile and needs of the home buyers. Regardless of the exact trajectory of the market, our experienced leadership team and 15,000 dedicated team members remain committed to successfully navigate the changing market conditions. We are better positioned than ever to create long-term value for our customers and shareholders. I look forward to building our success together. I'll now turn the call over to the operator for Q&A. Operator, we can now open the call up for Q&A.
Thank you, sir. To our audience today, if you do have a question, please press star one on your touch-tone phone. Just a reminder, if you're joining us via speakerphone today, make sure your mute function is turned off to allow the signal to reach our equipment. Once again, star one. Going first to Matthew Bouley at Barclays.
Good morning. Thank you for taking my questions. Congrats on the quarter and on reaching your leverage targets as well.
Thank you.
I guess on that point, with leverage down near 3 times, you authorized the repurchase, of course. What can you say about the M&A pipeline in this environment and relative to share repurchase? Should M&A be a larger priority this year, or do you anticipate kind of further deleveraging as you get towards the lower end of your leverage range there before M&A becomes a bigger tool? Thank you.
I think it'll be a little of both. We want to continue to delever. As I've mentioned in the opening remarks, we certainly want to expand our value-added platform. If some opportunities came along there to do so to buy versus greenfield, we would certainly look at it. At the present time, I don't anticipate any significant M&A, but certainly would consider some
Smaller M&A options from a value add standpoint as opposed to green fielding. Green fielding is just getting harder and harder these days with all the restrictions and permitting requirements, and it's just taking longer and longer to get buildings out of the ground. I would certainly be open to some smaller M&A activity and at the same time continue to delever a bit.
Secondly, just around the guidance. I think the first quarter EBITDA guide, given the gross margin performance, it would suggest there's still some offset, I guess, on the SG&A side. Is that just further commissions and incentives as in Q4, or is this kind of further heavy lifting around some of your investments? Really just how should we think about SG&A, I guess, beyond the first quarter and when some of these investments may kind of reach scale? Thank you.
Yeah. The discussion around SG&A, obviously, you saw the jump in the percentage. There's a couple factors. Obviously, as we deflate, there'll be some natural inflation, just like we saw the benefit in the earlier months in 2018. We did see commissions go up, and hopefully that was a clear explanation in that our commission plans are built to reward our salespeople for selling at higher margins. That reward is showing both in the fourth quarter and of course, a bit in the first quarter as well. The other major factors I would describe, comp and bennies is certainly an area where we've seen pressure over the last year. Unemployment is down, and we've certainly had to work to take care of our employees and make sure that we have good retention.
We have seen some headwinds in the areas of insurance, both medical and casualty, due to ever-increasing, it seems, medical costs in this country, as well as some of the hurricanes and the weather that we've seen. Some areas there where we have, and will likely continue to see some challenges with inflation. The team is doing a good job of managing expenses and staying disciplined, particularly in the controllable areas. Our benefits associated with the improvements of the operational excellence are certainly going to be felt throughout the year, and we anticipate increasing over time. It's important to remember seasonality, though, right? Q1 and Q4 are certainly our lowest volume periods, and that's when it will show the highest percentage of SG&A in any given year.
All right. I appreciate all the detail. Thank you.
We'll go next to Nishu Sood at Deutsche Bank.
Thank you. The sales per day guidance for 1Q19 implies that you're expecting, once you factor out the lumber price or the commodity deflation drag, about mid-single digits gains year-over-year in sales per day. That's obviously a pretty strong performance in light of some of the volatility that we've seen in the housing market. Some builders are reporting double-digit order declines, et cetera. Has the book of business, has it seen any effect from that for you folks? If so, when would you expect to see it? Your macro commentary sounded still positive, but just wanted to see if you could reconcile for us the pretty robust expectation for 1Q19 versus some of the other data points we're hearing from some of the public builders.
Yeah. I guess I'll start and of course, Jack can jump in. The components therein, I would say our expectation is more in the low single digits increase, particularly for single family. There's growth in the business. We've got of course a little bit of share that we think we've got line of sight to. Perhaps a little bit of rounding in some of the numbers that you're doing the math on, but we think it's in the low single-digit range. Reason for our confidence in that is really the performance we had in the fourth quarter, for starters, as well as the ongoing contact we have with our customers. The sentiment out there, despite the headlines, and we read them too, but the sentiment amongst the people on the ground is that a lot of what has concerned folks and has slowed people down has begun to abate.
Interest rates have dropped a bit. The cost of lumber clearly has dropped a bit, we think those encourage home buyers to get back in the game as things settle down a bit. The pause that we expected, we think is just that, a pause, things will get back to a more normalized level, while perhaps slower growth than we had seen at certain points in the past couple of years. Still growth. A lot of optimism out there. Despite some lumpiness, whether it be weather or a pause, we still have a lot of confidence in the underlying demand.
Got it. Okay. Second question, on the increased sales commissions, you had a fantastic record gross margin, as you mentioned, 27.1%. Let's suppose that the 25% is the normalized, and actually, I'd love your thoughts on that, whether that's still the case. 210 basis points above, quote-unquote, normalized. How much incremental sales commission did that drive in basis points?
Let's see. I guess the first comment I'll make is regarding normal. I still think that 25% is a reasonable proxy for normal in terms of gross margin. We've talked about that in the past. I think that's still true. When we talk about-
Comp and benefits, I don't know that I have a breakdown of the commissions as a percentage. I can tell you it's about half, a little less than half of the SG&A variance for the fourth quarter. It is a substantial amount.
Got it. As we think about this commission, was it larger because of the extreme volatility? Is the incremental sales commission against where prices were? I use the rough benchmark of the 25% normalized gross margin, but does the commission work that way? Or is it against improvement in gross margins so that the extreme volatility might have had a greater effect and pushed those sales commissions on stronger margins up more than they might have been in a more normal volatility environment?
Yeah. I think it's fair to say your assumption is right. If you think about it from a purely simplistic level, if we are making 20 points normally on some lumber and the underlying cost falls, and we talked about it being in the 30% range, it's a substantial increase in the profitability of that particular sale. Just like when we see inflation, the profitability goes south. We both reward and penalize our salespeople for achieving higher profitability and lower profitability, respectively. That net sort of compounding effect of improved gross margins generates a higher payout because the dollars have increased, and there's a premium associated with higher than normal, and in this case, much higher than normal, margin recovery. Does that make more sense? Is that clear?
No, that's great. Thanks for your thoughts.
Our next question is from Trey Morrish at Evercore ISI.
Thanks very much, guys, and a really good quarter. I want to talk a second about the margin trajectory outside of lumber. We understand that lumber can have quite a bit of volatility, just given the massive pull down. Could you give us some thoughts, some insights on what your gross margins outside of the lumber category look like? Were they also up as well, or were they kind of more flattish?
They were pretty flat. The only exception to that is where we've done work around our pricing optimization tools. We think that by managing and being a bit more disciplined in some of the tools that we have, we were able to drive, for the year, probably about $4 million worth of benefit in those initiatives, and a lot of that was in the fourth quarter.
I'll just add, we did see some improvement in the manufactured products category. As you know, we continue to invest in our truss plants and automate where we need to, and we're seeing some efficiencies there. Peter's right. Obviously lumber was up, especially the back half of the year. The other product categories were relatively flat, but we also saw a decent little bump in manufactured products.
Okay. Got it. Thanks for that. Turning back to the volume outlook that you're looking for 1Q. You said it's kind of low single-digit range. At this point, we're two-thirds of the way time-wise through the quarter, maybe not quite business and sales-wise. Would it be fair to extrapolate from your comments that you're probably tracking flat to probably up so far year to date?
I don't plan to change my guidance, and I think we'll make the guidance for the quarter.
Okay. All right.
It's implied, right? I mean, yeah. Absolutely.
Yeah.
Thank you.
Thanks.
We'll go next to Mike Dahl at RBC Capital Markets.
Morning. Mike is on the line for RBC. Just wanted to start off on the value-add products you guys continue to invest in and drive growth here, but we did see it step down a little in the fourth quarter. Can you talk about what drove some of that and whether you think that's broader market slowdown, or if we should expect a more consistent mid to high single-digit rates, or if you guys can re-accelerate that and continue to grow outside in those segments?
Yeah, that's a fair question. There's certainly a deceleration in the growth when you look at the numbers on a consolidated basis, right? I'd say some markets are still very healthy. Some markets have weakened. On balance, it's a bit slower. There is still a lot of demand for the value-added product, right? Despite, again, all of the terrible headlines, the demand hasn't really gone anywhere. It's still there. The availability of labor, the job sites not having sufficient people on the ground, are all still challenges for our customers. We still are seeing significant year-over-year increase in people investigating, expanding their use of prefabricated product, whether it be trusses or panels or the better framing system. We are seeing that and enjoying the benefits of that.
Gauging it on a quarter-by-quarter basis in terms of growth, trying to align it with the overall market growth, it's a challenging thing to do from a forecast perspective. Probably fair that it would step back a bit from its headier days last year when the overall market was growing at a higher rate, but we still anticipate healthy growth through 2019.
Some of it could be regional, too. A lot of the heavier use regions of the country are the Pacific Northwest and the Northeast, and those tend to be impacted a little more by weather than, say, Texas, which isn't impacted as much, but also isn't as much of a truss market.
Got it. That's really helpful information. Transitioning to your delivery optimization program. You guys have laid out some early successes you've had and a desire to roll this out to 75% of the branches before the end of the year. Can you help us think from a P&L perspective, some of the early results you've seen in the branches where it is, whether it be better SG&A, better throughput, something that we can help quantify the magnitude of the potential here?
Yeah, sure. We're looking at that number for 2018. Still early days in a lot of locations, but really positive feedback from the users. Those that have really adopted it and started to squeeze some juice out of it have seen some really nice benefits on the bottom line. As you can imagine, it impacts both gross margin in the variable costs as well as SG&A and some of the overhead costs. We think that from our analysis, we've seen about $2 million worth of benefit in 2018 from the delivery optimization tools, which is primarily the software that we've managed, as well as some other ancillary tools that we're using. We think that, of course, is going to grow as we get those locations implemented and then ramped up. Sort of a two-phase approach for each location.
I'll just add, in total, we see that as a company over the next several years is somewhere around a $20 million or $25 million opportunity, which translated, it means we need to be about 5% more efficient from a delivery standpoint and from a yard personnel standpoint, or said another way, somewhere around 30 basis points as a percentage of sales. It's a real opportunity, and I feel very good about being able to achieve those numbers in the coming years.
Got it. Thanks, and good luck.
Thank you.
We'll go next to Jay McCanless at Wedbush.
Hey, good morning, everyone. My first question, if lumber prices stay where they are now, theoretically, should we expect some de-leveraging on the overhead margin? Just assuming we stay like in this 350, 400 band for the full year.
Of course. Yeah, we think it's going to work on an inverse way as last year. The growth in commodities benefited us on SG&A as a % sales when it was inflating, and as it deflates, it'll go the opposite direction. We didn't add people, for example, when it inflated, we won't take people out when it deflates. Underlying that, I think we're very pleased with the fourth quarter results. There was some skepticism, if you recall, Jay, in the market about whether or not we'd be able to protect our margins in case of deflation and whether or not we would see the outsized benefit in our gross margin percentages that we claimed. I think our results certainly proved that we did what we said we would do. We'll manage through this year. There'll be some continued volatility.
Commodities always manage to throw us a curve ball or two. I think we're very well-positioned. We've proven our discipline and our ability to manage in both up and down markets, and we're going to do that this year and focus on the operational stuff that we know we can control, and we'll focus on making money on commodities and keeping the business in line and being disciplined.
I'll just add, I don't think I'm going on out a limb to say it's very likely commodity prices will not be as volatile this year as they were last year. I do think as we get into the spring and summer building season, we will see some inflation. Even that being said, it's likely going to be a bit of a headwind this year. All in all, as everyone knows on this call, we operate in a cyclical business, and this is just part of it. In a cyclical business, you have good years, you have bad years. 2018 was a good year. Despite maybe some additional headwinds in 2019 is going to be a good year. As Peter said, we will deal with what comes our way, but we feel really good about things as we sit here today.
The second question I have with the excitingly bad weather we've had in a lot of different locations this year. I'm assuming that the guidance y'all given on sales per day includes whatever weather benefit you've seen so far. Could you talk about that a little bit, what impact it's had on R&R? Also the other one I wanted to sneak in, could you repeat, and I missed this, I apologize, but just how much of the 2024 notes you guys bought in both in 4Q and this quarter?
To answer the second question first, it was about 75 total, 50-ish in Q4, and 25-ish in Q1. I'll make a couple comments on the weather. First of all, definitely not a benefit. I'm assuming you were being facetious on that one. Lot of disruptive weather, a little bit in the fourth quarter, more in the first. Candidly, we don't like getting into the weather reports, having heard other folks talk about it absolutely is real. Polar vortexes, blizzards, unusual snow in the Pacific Northwest, unusual rain in the Pacific Southwest. It is certainly an interesting time. We've included the bulk of what we've seen so far, I can't say tomorrow's weather pattern is focused in. We'll have to respond to that. We think it's pretty well baked in. Certainly a lot of West Coast disruption, upper Midwest disruption.
It's been problematic, but it is what it is.
Sounds good. Thanks, guys.
Thanks, Jay.
We'll go next to Matt McCall at Seaport Global Securities. Sir?
Thank you. Good morning, everybody.
Hey, Matt.
Good morning, Matt.
You talked about the bogey 85% average annual free cash flow as a percent of adjusted net income. Can you talk about that, how that looks in 2019? I'm specifically thinking about the impact of lumber on working capital. How do we think about 2019 relative to that 85%?
It's a good question. Part of the reason for not giving guidance is because depending on where the commodities goes, there goes my both EBITDA, and there goes my working capital, likely in different directions. Same true with single-family starts. The rationale for the change is people got hung up, candidly, on that long-range plan presentation with regard to the cumulative cash flow and kept trying to lock it back to, so what year? Our point in that is really to emphasize a normal housing market has a significant tailwind from where we are today on our results. Over time, our proven performance really syncs back very well to that sort of 85%.
Some years more, some years a bit less, right in that 85% range, historically and going forward, for cash generation that we can utilize to grow the business, to pay down debt, to continue to strengthen our balance sheet. We felt that was a more appropriate way of talking about it rather than a single dollar amount over a cumulative number of years. That was the rationale for the change. As we get into a full-year guide, we can add that to the list to provide to everybody that percentage for the year.
Okay. That's fair. I understand the uncertainty around what lumber does. I think in the past, you've talked about 9% to 10% working capital, 9% to 10% of incremental sales. If lumber stays where we are today, how should we think about the full year? Is that still a good rule of thumb?
I would say generally it is, you have to account for the lumber volatility as an impact as well, right?
Okay.
If you can tell me what my volume is and what commodities will do, I can tell you what my working capital impact is going to be.
Okay. I'll work on that.
Thanks, sir.
Chad, you said you're still going to focus on debt reduction. You've kind of gotten, I think, to the midpoint of the targeted range, if I remember correctly. Do you have a new target established, or as you just continue to work it down in the absence of an opportunity from here, how do we think about your net debt to EBITDA bogey?
Yeah. It depends. It depends on how we're feeling about the cycle and where we are. It depends on what opportunities may present themselves. I'm not going to turn a blind eye to opportunities if they come along. If something came along and it required us to pop back up to 3.5 or 3.8 times, but we had a clear runway of bringing it back down in short order, I'm not going to say no to, or at least not going to say I'm not going to look at something like that. Back in 2015, we had no idea ProBuild would come along, and I'm damn glad we did it. It really just depends on the opportunities that are out there.
I would say barring any significant opportunity that we want to look at, yeah, I'd say driving it down somewhere closer to 2.5 on a longer-term basis is probably what we'd be looking at.
Okay, perfect. Then last one. I think you broke out the CapEx that's going to be aimed at kind of new facilities, some of the truss, I think you said truss facilities, millwork plants, truss lines, and door machines. I guess the question is, what's the incremental add look like 2019 versus what you just experienced in 2018? How much are you going to add, either each one of those or the total?
We call that about a quarter of our CapEx. About a quarter of the 1.5%, we think, will be focused on those categories that I think you were outlining there.
What was the total in 2018 in those terms? About the same?
That's a good question. Probably about the same. Maybe a little less, but right in there.
Okay. All right. Thank you all.
Moving next to Steven Ramsey at Thompson Research Group. Sir?
Good morning. I would assume.
Morning
Just thinking about your locations sort of on a portfolio basis, and you continually assess KPIs and the outlook of each. From that perspective, did you close any locations last year or open any, and do you expect anything on that front this year? How do you look at the penetration of value-added products, penetration in locations, and the revenue capacity and generation of each? I guess, just kind of thinking locations basis, are you where you want to be?
I guess I can open it and then I'm sure Chad will probably want to jump in, but the decisions about opening and closing facilities in a given year, we know we opened, I think two this year and closed two this year. We're continuing to modify. We closed an operation in East Hartford, Connecticut, I think, and one in Oklahoma City, but kept others in Oklahoma City. We're constantly sort of looking for opportunities to take out businesses where the return isn't where we need it to be and add locations where we think either a greenfield or a product-specific location might help us out. With regard to capacity, on the value add side, each line, each type of equipment has certain capacity availability, and that's where we flex, right?
If we've got a location that starts to run up against capacity constraints but has manual equipment, we can move that manual equipment out to another location and bring in automated equipment and add a bunch of capacity into a locale. A little trickier on the lumber side. Your footprint matters. There are things you can do to improve efficiency, but there's some real space constraints that will limit the amount of dollars you can put through a facility, and that falls into the decision-making that we go through regularly about where do we need to add either square footage or acreage in order to run the business. It is an ongoing decision, and it is one of the things that we've really started to analyze a couple of different ways, right? We, of course, manage it on an EBITDA basis, on an EBT basis.
Also we're looking at it on an ROIC basis in order to make sure we're making wise decisions from a more strategic perspective.
Great. Then, thinking about R&R, slower in the Midwest, but broadly outside of the Midwest, is R&R activity performing more strongly when you look at it that way? Is your outlook from today, thinking about 2019, is it more predictably good? Are you able to kind of quantify a range on growth in that end market than you are with new construction?
I would say to answer your second question first, no, we are not quantifying growth in that space, largely because of our geographic exposure being in the Midwest, in R&R and other. In the Midwest, in Southern California, and up into Alaska. Those are sort of concentrated areas. At least in the Midwest perspective, a lot of uncertainty, candidly, with regard to the U.S.-China trade, and the impact on ag, soybeans, and pork in particular, and the resulting sort of hesitation by certain markets to really get aggressive in some of their sales and some of their investments. Southern California, as I'm sure everybody knows, very volatile market historically. That's proven true over the last couple of years as well, so I'm a little reluctant to call a ball on that market as well.
Then unfortunately, Alaska, despite the beginning of a recovery in oil prices in the fourth quarter, has sort of pulled back a bit. There's a bit more wait and see up there as well. I would say those are all reasons for uncertainty, not reasons for optimism at this point, but we're going to wait and see.
I wouldn't say the sky is falling, but the upper Midwest will be a challenge this year. I think Alaska will be a little better, and Southern California is a bit of a question mark right now. I would echo what Peter said. Don't see it going gangbusters. It could be a little sluggish this year.
Great. Thank you.
Thank you.
We'll go next to Kurt Yinger at D.A. Davidson.
Yeah. Good morning, everyone, thanks for taking my questions.
You bet. Yeah.
I just wanted to start off on going back to gross margin. If I did my math right, you're looking for 26% or maybe a little bit better in the first quarter. You mentioned 25% is still kind of a reasonable, normal figure. How quickly could we move back towards that as the year progresses? Is it something where you lose about 100 basis points quarter-over-quarter in the first quarter and the same in the second, or is it maybe more of a gradual step down?
Generally what we've said in the past, and I think it's true still now, is it takes about a quarter to work through inventory on the ground and the pricing arrangements we have with our customers. I would say, given that prices started running back up in Q1, Q2 is where you're going to see the vast majority of the impact.
Yeah, I think it'll pretty much have played out barring some unexpected change by the end of Q2.
Okay. Very helpful. Thanks. Looking at the $65 million-$75 million sort of improvement from operational initiatives returning to sort of mid-cycle building levels, is there any way to think about that savings between cost of sales and gross margin versus SG&A?
I would say it's probably a third margin, two-thirds SG&A.
Okay. Lastly, what's a good way to think about interest expense for the year?
Yeah. Our guide is about $95 million-$100 million.
Okay. Thanks very much.
You bet.
Thank you.
That does conclude today's question and answer session, and I'd like to turn things back over to Mr. Crow for any additional or concluding remarks. Sir?
Well, thank you once again for joining our call today. We look forward to updating you on the progress of our initiatives in the quarters ahead. If you have any follow-up questions, please don't hesitate to reach out to Binit or Peter. Thank you.
Ladies and gentlemen, once again, that does conclude today's conference. Again, I'd like to thank everyone for joining us today.