Builders FirstSource, Inc.
Q3 2022 Earnings Call Transcript

Published: 8 Nov 2022

[Operator:]

Good day, and welcome to the Builders FirstSource Third Quarter 2022 Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by management and the question-and-answer session. [Operator Instructions] I'd now like to turn the call over to Mr. Michael Neese, Senior Vice President, Investor Relations for Builders FirstSource. Please go ahead, sir.

[Michael Neese:]

Thank you, Todd. Good morning, and welcome to our third quarter 2022 earnings call. With me on the call are Dave Flitman, our CEO; and Peter Jackson, our CFO. Today, we will review our third quarter results for 2022. The third quarter press release and investor presentation for today's call are available on our website at investors.bldr.com. We will refer to several slides from the investor presentation during the call. The results discussed today include GAAP and non-GAAP results adjusted for certain items. We provide these non-GAAP results for informational purposes, and they should not be considered in isolation from the most directly comparable GAAP measures. You can find the reconciliation of these non-GAAP measures to the corresponding GAAP measures where applicable and a discussion of why we believe they can be useful to investors in our earnings press release, SEC filings and presentation. Our remarks in the press release, presentation and on this call contain forward-looking and cautionary statements within the meaning of the Private Securities Litigation Reform Act and projections of future results. Please review the forward-looking statements section in today's press release and in our SEC filings for various factors that could cause our actual results to differ from forward-looking statements and projections. With that, I'll turn the call over to Dave.

[Dave Flitman:]

Thanks, Mike. Good morning, everyone, and thanks for joining our call. Our strong third quarter results reflect the fundamental strength of our business, including our value-added products and services that resonate with our customers and our consistent execution. We are winning new business and strengthening existing customer relationships by consistently providing customers tailored solutions and excellent service, which collectively make us a partner of choice. In the third quarter, we delivered a 6.9% increase in core organic sales, including nearly 20% growth in our higher margin value-added products. That performance, combined with our investments in core operations, our relentless focus on cost controls and acceleration of productivity helped us produce record adjusted EBITDA. On Slide 3, I would like to remind you of our long-term strategic priorities

[Peter Jackson:]

Thank you, Dave, and good morning, everyone. I'm pleased to report that we delivered strong financial results in the third quarter. We generated a record quarterly free cash flow of $1.4 billion and repurchased $658 million of our common stock during the quarter, all while maintaining a strong balance sheet. Our financial performance reflects consistent execution, disciplined operational management and alignment with our strategic priorities. We are operating with a proactive mindset and have enhanced our already strong expense management processes amid a challenging operating environment. Our fortress balance sheet, low net leverage profile and substantial liquidity provide us with the flexibility to navigate a dynamic but decelerating market. All the while, we are maintaining focus on creating long-term shareholder value. I will cover three topics with you this morning. First, I'll review our third quarter results. Second, I'll provide an update on capital deployment. And finally, I'll discuss our guidance for full year 2022. Let's begin by reviewing our third quarter performance on Slide 9. We generated net sales of $5.8 billion for the quarter, which increased 4.6% compared to the prior year period. Core organic sales in the value-added products category grew by 19.9%, reflecting our work to enhance our product mix and meet customer needs. Gross profit was $2 billion, a 17.6% increase year-over-year. Gross margin increased 390 basis points to 35% as we increased sales in our value-added product categories and continued pricing discipline in what has been a supply-constrained market, but is returning to normal. SG&A grew 14.3% to $1 billion, with about half of that increase driven by two factors

[Dave Flitman:]

Thanks, Peter. I want to close by reiterating the underlying strengths of our business that will enable us to gain share in any environment. We are the market leader in a highly fragmented industry. We have a growing portfolio of value-added products and solutions that resonate with our customers, making us a partner of choice. We have a diversified revenue stream and are constantly optimizing our capacity and operations for long-term growth. We are laser-focused on operational excellence, which adds to our competitive advantage. We take a disciplined approach to organic and inorganic growth with a long-term focus. We generate significant free cash flow which enables financial optionality in times of uncertainty, and we consistently generate solid returns while executing our long-term strategy. Our industry is clearly experiencing deceleration versus the prior year, but we are not discouraged. We are confident in our ability to navigate through any market environment and we will remain proactive in implementing our downturn playbook to streamline costs and stay close to our customers and supply partners. We will continue to execute through near-term market volatility while keeping our sights on our long-term goals, our core values and our operating principles as our guidepost. Finally, and perhaps most importantly, we have a very strong, seasoned and highly experienced leadership team that has succeeded through many prior cycles and knows how to deliver compounded shareholder value over the long term. Thank you again for joining us today. Todd, let's please open the call now for questions.

[Operator:]

[Operator Instructions] We'll take our first question from Matthew Bouley of Barclays.

[Matthew Bouley:]

Congrats on the results. So the comments you made at the end there about sustaining a double-digit EBITDA margin in a scenario of 800,000 single-family starts. If I look at the Q4 guide, for example, I think you're implying something like a 70% decremental margin on EBITDA. I know we're kind of in that period of commodity normalization and loosening supply chain. But how does that decremental for Q4 kind of breakout between commodity and non-commodity? And then just kind of give us some comfort around what that decremental could look like in 2023 that sort of allows you to sustain that double-digit EBITDA margin?

[Peter Jackson:]

Sure. Yes. No, that's a good question. I think what you're highlighting there is what we're seeing in the market in terms of a confluence of numbers happening at the same time. So if we think about what Q4 normally is just in a traditional year, it's a decelerating time for us due to seasonality. We generally see a decline in commodity prices in those fall periods. And overall, the business is sort of buckling down for the win. This year, you overlay the market environment where you see a slowing market, you see a lot of the supply chain returning to normal and you see commodities decelerating into that as well as the seasonal decline. And so the trend, if you compare it to last year, obviously, is in the opposite direction in all of those categories. So what we're anticipating in that slower market is that decline in commodities, the decline in sales, some retrenching of the gross margins. We talked about that, I think, extensively over the last or so in terms of a return to normal over time. We're beginning to see all of those things play out. So that's really the dynamic in the fourth quarter. We've considered all of that in our discussion about where we think we would be at with 800,000 starts. We think that the normalized commodity prices, our ability to manage through the market as well as the strength of our business and our mix really will put us in a position to still be in that double-digit EBITDA space, considering all those factors.

[Matthew Bouley:]

Okay. Got it. That's helpful. Thanks for that, Peter. And then secondly, I wanted to ask about pricing. You guys mentioned a couple of times at the top that there has been pricing discipline in a supply-constrained market, but that market is now returning to less supply-constrained. I think if I play with your implied Q4 guide, I take what you said at the top around volumes tracking down low double digits. I could be wrong, but it seems like you might be implying that core pricing might also be negative in Q4. And please correct me if I'm wrong there. But just how are you guys thinking about price deflation on non-commodity products? And are you starting to feel more pushback from homebuilder customers there?

[Peter Jackson:]

Well, I'm going to give my customers plenty of credit. We always see pushback, right? I think that the dynamic in terms of the margins and the way that we're seeing margins flow through as a result of supply is, as you'd expect, right? As more supply becomes available, becomes more competitive, and that's what we've baked in. We do think there will be a bit of gross margin progressing back towards normal. We won't get there in the fourth quarter. But certainly, heading that direction. Competition is increasing, as you would expect, and we're ready for that. We're ready for the battle as part of kind of who we are and what we do. I'm not sure that there's a lot of detail that I can provide you, now a lot of pullback from vendors in terms of their pricing pass-through. It slowed down a bit in terms of increases, but we haven't seen cuts in any material way, but that could happen.

[Dave Flitman:]

Yes. I think that last point is an important one there, Matt. I think the volumes, the allocations that we saw for the last couple of years have pretty much gone away. But to Peter's point, outside of the commodities, we have not seen price concessions from our suppliers to this point.

[Operator:]

Our next question comes from Trey Grooms of Stephens Inc.

[Trey Grooms:]

Good morning, everyone. And I have to also say congrats on the great performance in the quarter.

[Dave Flitman:]

Thanks, Trey.

[Trey Grooms:]

So kind of just circling back for a little bit more clarity on that double-digit EBITDA margin you're referring to in that kind of single-family housing start around 800,000, Peter. And then also kind of going back to your long-term gross margin guide, 27%. I mean, you've talked about kind of margins progressing towards normal. Is that 27% kind of the -- if we kind of triangulate into that double digit, it seems like that's kind of the number you're pointing to in that environment. Am I off there? Or in that environment, is there a difference? And how we should be thinking about that long-term number?

[Peter Jackson:]

So the two pieces. The 800,000 is just an example. We want to give you a sense of where we think that double-digit EBITDA can be defended. This is all forecast. I don't want anybody writing this on stone tablets or anything, but it's what we think. I think we've got a good business. We know we've looked at our numbers six ways from Sunday, and we feel good about where we think we'll be even into a modestly down market. When it comes to the gross margins, we talked about 27% plus, somewhere north of 27% of normalized gross margin that we feel good about spending. There's a lot of question marks still about where things will settle out with margins given the dynamics in the marketplace. Certainly, it will be more challenging than it has been over the last year or two just because of the increased competition and the slower starts, but there's still reason to believe that improved discipline in the market, improved work within our organization about how we think about pricing will allow us to maintain a level north of 27%. Certainly not ready to give kind of refined guidance there. But a movement back from 35% towards that 27% is what we continue to point to and what we expect to see, both in Q4 but also in that sort of down 20% start -- single-family starts metric that we threw out there.

[Dave Flitman:]

I would just add, just on the double-digit EBITDA margin, I think you'll recall that neither legacy company had double-digit EBITDA margins at those sort of start levels. And I think we've been talking a lot since the merger about the strength of the platform that we've built and the differentiation that we have, and we're confident that we will see that play out through the cycle.

[Trey Grooms:]

Yes. No, that's -- I got that very loud and clear, and you guys are executing well with all of that. So hats off there. And on that, I guess the $100 million in productivity savings that you're talking about for the full year, how volume or sales-dependent is that? And I guess how much of that would be sustainable in a year where if we were looking at that kind of housing start environment?

[Dave Flitman:]

I'll start, and then I'll flip it over to Peter. When we outlined our forward projections and our financial plan at the Investor Day a year ago, we said importantly that we were targeting over the long term 3% to 5% in fixed cost productivity. And what you're starting to see as that play out, and we started slowly through the integration of the merger and we put those synergies behind us, and we've stepped on the gas on operational excellence, and we continue to build momentum. So the clearest answer that I can give you is we believe we are building fundamental strengths in that area of the business. There's lots of opportunity to continue to optimize what we do and get more efficient, and we're confident that we're going to move towards that long-term target over time.

[Peter Jackson:]

Yes. And I guess all I would add there, Trey, is that while there will certainly be volume adjustments to certain items that are volume-driven, these are operational changes, right? We're tracking them as a finance organization to ensure that there's real P&L impact and things that have changed before and after. We're not just tracing volume improvements and telling you the leverage number. These are changes in operations, process, staffing expenses that you contract because we've done things differently to get rid of waste and improve our efficiency.

[Operator:]

We'll take our next question from Mike Dahl of RBC Capital Markets.

[Michael Dahl:]

So Dave, Peter, thanks for the additional color so far. One more follow-up on the '23 sensitivity. I appreciate it's a very high level at this point. If I think about, as you acknowledged, builder orders down 30% to 40% in recent months. The lag that, that hits you with in a starts environment of 800,000 or down 20 next year, it's possible that the lagged impact to you as potentially even worse. And so does that sensitivity contemplate that? Or I guess, maybe ask the somewhat different way. That's the level. It sounds like you're comfortable saying you can defend double-digit margins. What type of decline would it take in your sensitivity to drive margins below double digits?

[Dave Flitman:]

Yes. I think it's a little early for us to dig in, Mike, on 2023. We certainly -- we're in the midst of our budgeting process here. We'll finish that up before the end of the year, as you'd expect. We certainly don't want to get ahead of our customers on any projections. As you know, it's a challenging market, and it's changing day by day. And we just gave that example as illustrative in the confidence. And as I said on the last question, we're in a different realm of capabilities in this organization and this company we've built than we were anytime in the past. So that was really illustrative and really didn't mean to opine on what starts may be next year. It's too early to tell.

[Michael Dahl:]

Got it. Okay. My second question, just on the capital allocation. Obviously, you've got free cash flow to support your goals this year and really nice buyback activity. You have leverage on the base business ticking up a bit. If you're looking out to next year and anticipating some core declines in the business, while you may throw off some strong free cash flow, it seems like it's possible that leverage could keep ticking up towards the upper end of your 1x to 2x range. So how are you thinking about the relative aggressiveness of your buyback program? You've got funding earmarked for M&A. You've been really aggressive on the buyback. Is it time to toggle that back a little bit? Or any thoughts on how you're looking at the buyback going forward?

[Dave Flitman:]

Sure. Thanks for the question. So look, our capital allocation priorities have not and will not change through the downturn. We'll invest first in the future growth of the company, inside the company. We'll look at M&A next and we'll return capital to shareholders as our third priority. However, even in the M&A front, our pipeline is still very strong, valuations have to make sense, and the same thing around share repurchases. So we, to this point, Mike, have been very disciplined stewards of capital. We will be disciplined stewards of capital through the cycle. We've got a bulletproof balance sheet. We're very comfortable with that. Sure, to your point, our leverage may tick up some. We believe our cash flow will remain strong, and we're going to do the right things with our cash.

[Operator:]

We'll take our next question from Ketan Mamtora of BMO Capital Markets.

[Ketan Mamtora:]

Thank you. And congrats on a strong quarter. Peter, coming back to the example that you gave and whatever starts drop we may see next year, whether it is 10, 15, 20, whatever that number may be, but I'm just curious kind of how does that impact your base business EBITDA of $2.2 billion. It's not the margin, but just the absolute EBITDA. Should we think about it, with single-family as 3/4 of your total business, should we think about it as a similar drop in the base business EBITDA, should be greater, should be less? Any sort of high-level perspective on that will be helpful.

[Peter Jackson:]

Sure. Yes. No, that's a great question. If you think about our base business, it really is representative of the core of our operations and how it is functioning at the combined entity post-merger, but more importantly, through the cycle. So it is fair to expect we would see sales on the base business move based on starts. It's the best predictor of our business in the long run. Single-family starts, multi-family starts representing probably a combined 80% roughly of our overall sales. As you think about the dynamics within the space more broadly, there has also been, and we've talked about this a lot, a pretty significant impact on gross margins due to the supply chain issues. So certainly, we would expect gross margins to normalize a bit. If you think about the -- if you implement, as you described, a number of scenarios around single-family starts or all starts declining and you account for gross margins, there is some delevering that is going to happen in the overall business. That's the nature of the math, right? We'll still be healthy. We'll still be very strong. but there is going to be a smaller amount of EBITDA to be gained on a smaller business with more competitive gross margins. So that's broadly how I would describe it. What I would say are the counterpoints to that is the increased investments we're making in value add, the share that we're gaining and the productivity improvements we're making in the business just to be better at what we do. So there's a balance there. That's what we're working through right now and are planning for '23 to be able to give you better dialed-in numbers.

[Ketan Mamtora:]

No, this is great. Very helpful. And then one other follow-up question. So obviously, we are starting to see cancellation rates tick up, starts come down. But I'm just curious, how long do you think it will take for builders to work through sort of the current backlog of homes that are there? Is it sort of a one to two quarter event or less or more?

[Peter Jackson:]

That's a great question. I really wish I knew the answer to that. On one hand, I think we've seen really nice trends in terms of those numbers of units, those homes under construction in total stay quite high, which indicates there's some cushion there. The counterpoint is a little bit what we alluded to in the script today, we have seen a bigger decline in the early products. So say that another way, if you think about the construction cycle of a home, you're going to start with your framing lumber, you move to trusses, then windows and doors, we're seeing bigger declines on the earlier products which would indicate that we're starting to build through some of that unit under construction backlog. Timing of it, tough to say. I think the most common forecast that I've heard would be Q4, Q1, we would burn through the bulk of it, but I think it's just too early to say.

[Ketan Mamtora:]

Got it. That's very helpful. I will turn it over. Good luck in the back half and into 2023.

[Operator:]

We'll take our next question from Adam Baumgarten of Zelman & Associates.

[Adam Baumgarten:]

Just going back to the September and October volume trends, maybe give us a sense for how the value-add business performed? Did it continue to outperform the overall business in a down environment?

[Peter Jackson:]

It did. It did. There's a few reasons for that. I mean, obviously, we've invested in the value-add part of our business over the last year. So both in the form of internal investments, new capacity, better facilities, better automation, better productivity, but also in the inorganic side with the acquisitions we paid. Both of those have done well and then you layer on the other components, right, windows, doors and millwork, that's an area we've made a lot of investments in over the past really decade and that has yielded some really nice performance and ability to compete. So our focus in those areas is paying off. We think it will continue to do that. Now that isn't to say that we won't still face challenges in a market where there's fewer starts, but we think we're very, very well positioned to compete to win in that environment.

[Adam Baumgarten:]

Got it. And then maybe just some additional color on mybldr.com that launch that's coming up. It sounds like it's targeted towards smaller builders. Is that an incremental opportunity to the $1 billion that you guys have sized over time? And then maybe just maybe the market opportunity for that launch just in and of itself would be helpful.

[Dave Flitman:]

Yes. Very good question. And no, it's not incremental to the $1 billion. As we said, we bought a platform that was -- we were very excited about with Paradigm, but it was very narrowly focused again on window and door manufacturers in the retail side of the business. And as we said, we've been investing heavily in the development of that platform to build it out to be able to handle the whole house design and configuration. We're hitting a major milestone with that launch. And as we've said from the beginning, we are targeting this at the small builders first. So consistent with what we said, we're excited about that milestone. And there will be more to come over time. But 15, 16 months in, with the heavy lifting we have and continue to have on the development side, and we're excited to bring that forward.

[Operator:]

We'll take our next question from Collin Verron of Jefferies.

[Collin Verron:]

I just wanted to start back with your illustrative 20% decline in starts environment. Can you just provide some more color about the organic sales declines and the decremental margin assumptions that go into that? I ask just because you're taking share, especially from the value-add products, there could be some changes in core pricing. So there seems to be a lot of moving pieces here and beyond just the single-family starts. So any color there would be helpful.

[Dave Flitman:]

Colin. Yes, I mean, to be honest, the goal wasn't to try and get into the dissection of the sub numbers. I think that my comments that -- to Ketan a little while ago are certainly applicable here and that we do anticipate there to be declines on a number of different areas. We think starts will go down. We think commodities will continue to revert back to that long-term average. And we think there'll be some regression to the historical norms in margins. Beginning to see that in the third and fourth quarters and certainly expect that to play out through the year. But it's an environment where even with those pretty significant slowdown estimates included in the metric, we're still at double-digit margins. We're still in a position where we've got a market-leading platform where we've got investments in value-add and digital and improvements internally and our productivity is helping to lead us through a very difficult time with a very profitable business. So it's certainly inclusive of those factors. You're right, and we'll have a lot more detail for you as we get into the February announcement where we give the guide on '23.

[Collin Verron:]

Okay. And then can you just touch on the M&A pipeline and your strategy here just given the weakening macro environment, what kind of purchase multiples you're seeing in the market and maybe how that's different from history?

[Dave Flitman:]

Well, we've still got a very strong pipeline as we said for a while now. Valuation becomes the issue at times like this, right? And we've executed so far, 13 acquisitions since the merger, all we believe with high level of discipline on valuation. And we will continue to do that through the downturn. I expect that things may slow down a bit here for a while. And dependent upon the length and the severity of the downturn, the pipeline may get more active through the course of time. But again, I just want you to hear and understand we have been and will remain disciplined on valuations.

[Operator:]

We'll take our next question from Reuben Garner of The Benchmark Company.

[Reuben Garner:]

Good morning, everybody, and congrats on the results in the quarter. So the value add versus the commodity or non-value-added businesses, can you talk about what you're seeing on the margin front so far in this quarter or towards the end of the last quarter? Have the value-added margins kind of held in better and commodities kind of already returned to "normal" or have they kind of progressed in a similar manner?

[Peter Jackson:]

Yes. So good question. The margins have, as you did maybe expect, begun to return to normal, but led more by the commodity side than by the value-add side, right? Historically speaking, value-add, prices and margins are a bit stickier and commodities are just -- they move more quickly. They respond more quickly just given the volatility of that cost category in general. We would expect that to continue, right? We would expect it over time to normalize quicker. We just haven't gotten all the way yet. We've got a little bit of it.

[Reuben Garner:]

Got it. And then for the scenario that you provided for next year as well, I guess you mentioned facility rationalization. Any more detail that you can go into there? Is that mothballing of manufacturing capabilities? Is that just consolidation of distribution footprint? Is it none of those? And what kind of, I guess, savings are embedded in that outlook? You mentioned making some cost cuts to kind of weather the storm. Is there any kind of dollar amount that you could throw out there?

[Dave Flitman:]

Yes. I would just say that to this point, from the peak, we've taken out about 2,600 of our headcount and that peak being really at the end of the second quarter, early in the third quarter. We have rationalized or in the process of rationalizing 17 facilities. And to your question, I just want to be clear, we are not taking out manufacturing capacity. This is more consolidation primarily in some of the smaller markets where we may have redundant assets that given the last two years and the strength of the market, we have not needed to shut those facilities down. In fact, we've needed all that capacity that we've had, but times are different now. And so I really don't want to quantify any of that at this point. But as I said on the call, we will be proactive and decisive in actions given what happens in the marketplace.

[Operator:]

Our next question comes from Keith Hughes of Truist.

[Keith Hughes:]

A question on multi-families. Continues to be strong as you discussed in your guidance. I guess how long of a backlog or how long of a view do you have a multifamily continuing in anywhere near this kind of level?

[Peter Jackson:]

Keith, yes, thank you. Multifamily is a bright spot. I mean, as we've talked about, there is a need for housing people need a place to be, and it would appear that with the slowdown in single-family starts, multifamily is certainly staying strong. And we have a great franchise in that space. The ability to invest is something that we've stayed committed to our existing multifamily business on truss and millwork we added to that with both Panel Truss and Trussway this year with acquisitions. And right now, we've got over of $1.2 billion to $1.3 billion of backlog in that space that we know we're going to be able to meet throughout the year. Certainly feel good about the strength and the profitability of that business and as we bring the teams together and integrate them into a consolidated Builders FirstSource team, we're excited about what they're able to deliver. So we're certainly very optimistic in that space.

[Keith Hughes:]

And on multifamily, activity planning and start activity slows down. What's kind of -- how long it take to show up in your numbers?

[Peter Jackson:]

Generally, you're talking about multifamily being a substantially longer lead time. We usually say around nine months. Yes, it's usually around nine months versus 30 to 60 days probably on the single-family side. It does vary a bit, but that's a good average.

[Operator:]

Our next question comes from Stanley Elliott of Stifel.

[Stanley Elliott:]

A quick question on the Slide 8. You talked about some of the downside actions you guys are taking. With the double-digit EBITDA margin framework that you've laid out, is that saying that you basically need to complete all of these downside actions? Or can you hit those targets where you are? And I was thinking more just from a leverage standpoint into next year, should things decelerate from here?

[Dave Flitman:]

We didn't lead those actions directly to those double-digit EBITDA margin. That was more illustrative and given you an indication of the levers that we have to pull, depending upon how severe the downturn gets. And the Harvey Balls there just show you that we're fairly early into acting on all that capability. So I wouldn't think about those as directly linked. But certainly, where the downturn gets severe, we will pull more and more leverage as time goes on.

[Stanley Elliott:]

And I guess switching gears on the automation side. You talked about some high-return CapEx projects. Could you help us kind of where you are? I mean I saw the CapEx guide come down modestly. What are expectations for some of those projects? And how should we think about them at next year?

[Dave Flitman:]

Well, as we have been, we continue to invest heavily in automating our manufacturing facilities. We think that's the right long-term play. We think labor is going to be constrained in this industry and particularly skilled labor, which we need in our manufacturing facilities for a long time to come. We talked about our first fully automated four truss line that we started up in Georgia last quarter. And at that time, we said we had eight more coming over the next couple of years, and we are fully committed to that and looking to future automation potential across our facilities. That's the right long-term play in any market. We will continue outside of maintenance of our facilities and refreshing our rolling stock. That is the single biggest area we'll deploy capital into the company going forward.

[Peter Jackson:]

And sadly, given the strength of our balance sheet, we have the ability to do that even in a slower market. And I think taking advantage of those windows where we can actually get access to some of this equipment that we need, it is the right way to manage for the long term, right? We haven't been able to get all the trucks, we haven't been able to get all the equipment we need, but we do have the ability to continue to refresh the fleet and do what we need to, to have that equipment when we need it even right now when things are slowing down.

[Operator:]

Our next question comes from Kurt Yinger of D.A. Davidson.

[Kurt Yinger:]

Just on the gross margin front, has the speed at which you've seen that start to normalize, I guess, in the latter part of Q3 and into Q4 surprised you at all? And then is that 27% kind of dependent upon a certain start assumption?

[Peter Jackson:]

Thank you for the question. So I think that the 27% is in a band of starts. I don't know if it's a specific number. And honestly, the 27% plus is unfortunately, at this stage, a bit hypothetical. We're going to have to watch the market and see how it pans out with the combined entity and the starts that we grapple with. Still feel good about it by what we've seen so far. I would tell you if I'm surprised on the gross margin side, just from a forecasting perspective. I would tell you I'm surprised it stayed as strong just as long as it has. It's done quite well. It's migrating down, but in a very measured way.

[Kurt Yinger:]

Right. Okay. That's helpful. And then just lastly, I mean, as builders start to kind of zero in on the cost side with the loss of some pricing power and maybe trade availability becoming incrementally better, how do you think about that impacting the value proposition of some of the value-added offerings?

[Dave Flitman:]

Yes. We're excited about the long-term potential of those value-added offerings in any market. You think about it, labor may be more readily available. But even in a downturn, efficiency at the job site matters for our customers. They're going to be doing a lot with a lot less people. They're going to take some of the same actions that we described that we're taking here. And any way that we can make their work more efficient, we believe we'll continue to get traction and continue to drive growth in those products. And to Peter's earlier comments, we haven't seen any slowdown in our value add on a relative basis compared to the rest of the business. We think our penetration will continue.

[Kurt Yinger:]

Got it. All right. Well, I appreciate the color, and good luck here in Q4 guys.

[Operator:]

Our next question comes from Alex Rygiel with B. Riley.

[Alex Rygiel:]

Can you talk a bit about your inventory level, your comfort with it, how it compares to historical levels? And any other sort of inventory that could be sort of out in the channel, understanding that you are most of the channel?

[Peter Jackson:]

Thanks, Alex. Yes. So inventory has been a real focus for us as we've observed the market, trying to make sure that we're we have the right amount on hand, right? We generally manage it on a days basis in the field ensuring that we're able to support the dynamics in the market. So that requires us to stay close to it up in -- during up and down moment. That said, I think we're in the right position. I think we've repositioned and cleared the decks on what we needed to. We talked a little bit about windows being an overhang. Certainly, we've made progress on that. A little bit more to go. But from a company -- total company perspective, it's pretty immaterial. So we're feeling pretty good. Certainly, there's always improvement, we can always optimize but certainly well within the band of where we'd like to be.

[Alex Rygiel:]

And then secondly, on Slide 17, that shows your estimated base business on certain commodity prices. It would appear that you didn't change it since the second quarter despite a number of acquisitions. Is there a sort of two or three simple explanations for them?

[Peter Jackson:]

Yes. We don't full year adjust the new acquisitions. It's just the part years. We're trying to keep it linked to the current look and then applying the normalized margins and the lumber prices. We've talked about a couple of different ways to update that sensitivity. We think we're going to have something that might be a little more helpful to folks when we do our Q4 announcement. But it has stayed the same. It has not moved materially primarily because it's just the part year additions for any M&A.

[Operator:]

It appears we have no further questions at this time. This will conclude today's third quarter earnings call. We thank you for your participation. You may disconnect at any time.