Builders FirstSource Inc (BLDR) 2016 Q1 法說會逐字稿

Good morning, and welcome to the Builders FirstSource first-quarter 2016 earnings conference call. Today's call is being recorded, and will be archived at www.bldr.com. It is now my pleasure to introduce Miss Jennifer Pasquino, Senior Vice President Investor Relations. Please go ahead, ma'am.

Thank you. Good morning, and welcome to the Builders FirstSource first-quarter 2016 earnings conference call. Joining me today on the call is Floyd Sherman, Chief Executive Officer, Builders FirstSource, and Chad Crow, President and 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 www.bldr.com.

At this time, all participants are in a listen only-mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. Any reproductions of this call, whole or in part, is not permitted without prior written authorization of Builders FirstSource. And as a reminder, this conference call is being recorded today, May 6, 2016.

Builders FirstSource has issued a press release after the market closed yesterday. If you don't 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 take statements containing the Company's future prospects, financial results, business strategies and industry trends. Such statements are considered forward-looking statements of 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 SEC, 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 acquisition of ProBuild closed on July 1, 2015, the closing date. As a result, ProBuild's financial result are only included in the Company's GAAP financial statements from the closing date forward, and are not reflecting the Company's historical financial statements. We have therefore provided supplemental financial information of the combined Company in this press release as pro forma or adjusted, which includes ProBuild's financial results for the relevant period, prior to the closing date.

The Company will discuss these pro forma and adjusted results on the call. We've provided reconciliation 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 available on our website. At this time, it is my pleasure to turn the call over to Mr. Floyd Sherman.

Thank you, and good morning. Welcome to our first quarter 2016 earnings call. Before I comment on the business, first I'd like to provide an update on the integration in progress against the cost saving initiatives outlined when the acquisition of ProBuild was announced. Then I'll give a brief recap of the quarterly results and turn the call over to Chad, who will discuss our financial results in more detail. After my closing comments regarding our outlook, we'll take your questions.

Let's begin our discussion on slide 4, with an overview of the key benefits of the combination. On July 31, 2015, we completed the acquisition of ProBuild, one of the largest distributors of building materials to professional builders, contractors, project oriented consumers in the United States. The combination created a clear industry leader, with expanded gross margin opportunities. We believe that the benefits of the acquisition include increased scale and diversification, enhanced cross-selling opportunities for value added products, better customer penetration, and projected $100 million to $120 million of targeted annual cost savings before one-time expenses.

We've created a more diversified Company, with enhanced scale and an improved geographic footprint. We are the leading distributor of lumber and building products to the professional building channel. With our presence in 40 states and 74 of the top 100 MSAs, we are striving to become the supplier of choice for all homebuilders. Our national scale facilitates strategic partnerships with customers and suppliers, and this allows for better customer reach and less exposure to any one market.

Sales in Texas accounted for 17% of our 2015 pro forma sales, with sales still at roughly evenly between Dallas/Fort Worth, Houston and San Antonio/Austin. No other state accounts for more than 8% of our sales. With 23% of our sales attributed to the repair and remodel end market, we have also reduced cyclicality through broader sales exposure. The repair and remodel end market has proven historically to provide a more stable revenue base, with strong gross profit margins and good returns. We feel the geographic diversity and expanded customer base has added both stability and value to our business model.

Now turning to slide 5. We're very pleased with the progress of the integration efforts thus far. The combined Company is operating effectively as one, providing best in class service to our customers, growing local market relationships, and delivering on our business objectives. All aspects of the integration, including system conversions and facility consolidations, are in full swing and progressing as planned, including closing all but one of the planned overlapping locations.

We plan to complete 88 ERP system conversions by the end of 2016, and have migrated 25 so far with minimal disruption or issues. Employee and customer attrition has been very minimal.

Moving to slide 6. We are more convinced than ever that we will deliver the $100 million to $120 million anticipated annual run rate cost-saving synergies that were outlined when the deal was announced. Synergies are being captured through network optimization, procurement, and G&A costs, with a breakout of about 20%, 30%, and 50% expected for each area, respectively.

Within 10 months of the acquisition close, we've already implemented cost savings initiatives that are projected to yield approximately $65 million to $70 million in future run rate savings. These savings include $12 million to $13 million in projected procurement initiatives, where scale improves our purchasing leverage.

We've also executed against the savings that are exclusively in our control, including $7 million to $8 million in projected network consolidation savings and $46 million to $48 million in projected overhead and SG&A savings, including benefit plans. We expect that our ongoing costs initiatives will benefit FY16 by $65 million to $70 million, and we realized $17 million in the first quarter.

As part of the integration process, we expect to incur $90 million to $100 million in one-time costs to achieve these synergies. Approximately half of these one-time acquisition and integration costs were incurred by March 31, with $25 million expected the balance of 2016.

Our integration efforts and cost savings realization are a major priority for us. I remain convinced that the combination will continue to create value for our shareholders and customers alike in the years to come.

Now moving to slide 7. I'm pleased with the sales volume growth over the prior year, indicating a strong start to the spring building season. We believe that sales were benefited by the milder winter, as well as the strong building fundamentals.

We grew in all categories, despite the negative impact of commodity deflation on our sales. Average market prices for framing lumber in the quarter were down 11% versus the first quarter of 2015. Despite this deflation, our lumber and lumber sheet good sales were up 8% versus the first quarter of 2015.

Our value added sales of manufactured products -- windows, doors and millwork -- in the quarter increased 14% versus 2015, and mix in these products increased 160 basis points over prior year. We believe our Company is well positioned to help homebuilders mitigate the impact of well-publicized labor shortage, and increase cycle times through our manufactured and valuated products across our national footprint.

Before turning it over to Chad, I'll give a brief recap of our results for the first quarter. Sales were $1.4 billion, up 9.1% as compared to last year, excluding the impact of closed locations. And we grew adjusted EBITDA by almost 200%, or $41 million.

I'm pleased with the growth in sales and profits over the prior year, especially considering the $86 million, or 6.7%, negative impact of commodity deflation on our first-quarter sales. Excluding the impact of deflation, our new residential volume sales grew 16% in the quarter, and repair and remodel grew 15% versus the prior year.

Of the total 15.8% sale volume growth in the quarter versus 2015, we attribute approximately 1.5% growth to the extra sales day. Additionally, lumber prices have rebounded 11% over the last 8 weeks, and we hope this trend continues. I'll now turn the call over to Chad, who will review our financial results in more detail.

Thank you, Floyd. Good morning everyone. I will first discuss the quarter results on slide 9. As a reminder, we have reflected pro forma adjusted figures to include ProBuild's financial results, prior to the closing date and adjusted for one-time integration, closure and other costs.

For the first quarter, we reported net sales of $1.4 billion, a 9.1% increase compared to pro forma sales for the first quarter of 2015, excluding the impact of closed locations. Total sales volume grew 15.8% over pro forma sales for the first quarter of 2015, but was offset by 6.7% as a result of the negative impact of commodity price deflation on our sales. We estimate that sales volume grew 16% in the homebuilding end market and 15% in the repair and remodel end market.

Breaking down our first quarter 2016 pro forma sales by key product categories, excluding the impact of closed locations, manufactured products were $237 million, up 15.6% from 2015. Windows, doors, and millwork were $312 million, up 12.4%. Lumber and lumber sheet goods were $466 million, up 7.9%, from $431 million in 2015, despite commodity deflation.

Our other building products and services categories were collectively up 4% compared to last year, on a pro forma basis. From a product mix standpoint, our value add product categories made up a higher percentage of overall sales, as our prefabricated components -- windows, doors and millwork categories -- accounted for 39.3% of sales in the first quarter of 2016, compared to 37.7% last year. Our lumber and lumber sheet goods declined as a percentage of sales, from 33.7% in the first quarter of 2015 to 33.3% this quarter.

If composite, framing lumber and panel market prices stay at current levels, we anticipate the full-year impact of commodity inflation or deflation to be minimal on a year-over-year basis. As you may remember, commodity deflation negatively impacted our sales somewhat in the second quarter last year, and to a much greater extent in quarters three and four of 2015. If commodity prices hold, we hope to recoup the sales impact of commodity deflation in the second half of this year.

Our gross margin percentage was 25%, up approximately 90 basis points from 24.1% last year. Our gross margin percentage increased largely due to improved customer pricing, commodity price deflation, and a higher mix of value added sales. Our procurement saving initiatives has just begun to materialize.

Our SG&A as a percentage of sales, excluding D&A and one-time integration and acquisition expenses, decreased by 190 basis points as a percentage of sales. This was largely attributed to the synergy savings realized in the quarter, as well as leveraging our fixed cost on increased sales.

Interest expense was $35.2 million in the quarter. In February 2016, we entered into debt exchanges, which reduced our long-term debt by $14.8 million and annual cash interest by approximately $9.9 million. As a result, a net gain of $7.8 million, related to the extinguishment of debt, was booked in the quarter, which reduced our interest expense. We have provided a normalized view of cash interest in our earnings release financial schedules.

Income tax expense for the three months ended March 31, 2016 was $4.5 million, primarily relating to deferred tax expense arising from the amortization of goodwill for tax purposes. We currently estimate our full-year effective tax rate to be approximately 22%. The Company had a federal net operating loss carry-forward balance at year end 2015 of over $280 million, against which the Company has a full valuation allowance recorded.

We do not anticipate paying any federal taxes in 2016, and expect to pay roughly $5 million to $6 million in state and other taxes. Adjusted net loss was $11.6 million, or $0.11 per diluted share, compared to a loss of $55.9 million, or $0.52 per diluted share, in the first quarter of 2015. We produced another quarter of strong adjusted EBITDA, totaling $61.8 million or 4.4% of sales, compared to $20.8 million, or 1.6% of sales, for the first quarter of 2015. This represents an increase of $41 million, or 197%, over the first quarter of 2015.

The Company was able to realize $17 million in synergy savings in the current quarter, before one-time cost to implement, which is in line with our previous guidance. We continue to grow our business in a profitable manner, as evidenced by the approximately 90 basis point expansion in our gross margin percentage and the approximately 280 basis point adjusted EBITDA margin growth we achieved this quarter. We have provided an adjusted EBITDA reconciliation on slide 12 of the presentation.

Turning to slide 10, cash flow in the current quarter was in line with our expectations and annual guidance. Total liquidity at March 31, 2016 was $623 million, consisting of net borrowing availability under the revolving credit facility and cash on hand. As of March 31, the Company had $59 million of outstanding borrowings on the revolving credit facility, generally flat with year-end 2015. While we expect to continue to borrow under the revolving credit facility for seasonal working capital and other operating needs, we do expect to pay down additional debt in 2016.

Adjusted pro forma EBITDA on a trailing 12 month basis was $354.3 million, and net debt was just under $2 billion as of March 31, 2016. This implied a multiple of 5.5 times net debt to adjusted EBITDA. The Company reduced its net debt to adjusted EBITDA ratio by over one half turn in the first quarter of 2016, and a full turn since the third quarter of 2015, from 6.5 times, to 5.5 times. Assuming the full realization of our expected annual cost savings synergies of $110 million, net debt to adjusted pro forma EBITDA would be 4.5 times.

We are intent on making significant strides in reducing the absolute levels of debt and deleveraging the balance sheet over the next few years. We intend to do so through cash generation and paying down debt, although we may, from time to time, enter into opportunistic transactions that lower our interest expense and otherwise address our capital structure, allowing us to even further de-lever the balance sheet. In February of 2016, the Company exchanged $282 million in aggregate principal amount of our 2023 notes, or $268 million of our 2021 notes, to reduce its annual cash interest expense by approximately $10 million.

We have provided an interest reconciliation, to provide a normalized or ongoing view of interest expense and current debt levels. Turning to slide 11, there are about five years until our first debt maturity, and we expect free cash flow generation will enable us to meaningfully reduce the absolute level of debt between now and then. We believe this will be driven by EBITDA growth, including projected annual cost savings realization of $100 million to $120 million by the end of 2017, and a focus on working capital efficiency, which we believe will run between 9% and 10% of incremental sales.

We will invest in our business through capital expenditures at approximately 1.5% of sales, and we plan to utilize our carry-forward NOLs, which were in excess of $280 million at year end, to shelter us from paying federal taxes through 2016 and much of 2017. In 2016, we expect one-time cost of $30 million and cash interest of approximately $157 million. As a result, we continue to expect to generate approximately $75 million to $80 million in cash flow in 2016. This is consistent with the guidance provided last quarter. Once we have these synergies fully realized and one-time cost behind us, we expect the Company's cash flow will significantly increase on a go-forward basis.

We're focused on reducing debt, and are optimistic about our cash generation opportunities. Should market conditions unexpectedly accelerate or decelerate, we have the ability to quickly adjust our capital spending and working capital accordingly, to largely mitigate the impact on our cash flow. I'll now turn the call back over to Floyd for his closing comments.

Thank you, Chad. I'd like to take a moment to send our thoughts and prayers out to those in Houston who have lost their homes and more to the tragic floods. As you know, Houston is a very important market to us, representing 4.5% of our sales, and we have long-standing ties to the market. Thankfully, all of our employees are safe, and our facilities, equipment and inventory were not damaged. I want to personally thank all of our associates in Houston for their efforts in getting our business back up and running so quickly, so we can help our valued customers in the Houston community start to rebuild.

Turning to our outlook, I remain very positive about the future of our Company. I believe our industry remains on a trajectory of solid growth. I'm encouraged by the recent framing lumber composite price inflation, an increase of 11% since early March, and we expect to grow profitably and realize our synergy cost savings. Our Company is well positioned to be the building supply company of choice for builders around the country, thanks to our geographic reach, enhanced product offerings and national manufacturing capabilities, and various superior customer service.

Our focus will be to leverage our national scale and sales capability to grow faster than the market, with a focus on profitable growth and value added products. These strengths, our scale and the potential leverage provided by the synergy savings, combines to make Builders FirstSource an industry leader with significant opportunity to drive profitable growth. We've demonstrated our ability to reduce debt again this quarter, and we're committed to continue to reduce leverage through annual cash flow generation.

We will continue to create value for our shareholders and customers by executing against our synergy and growth plans. I attribute the success we've achieved in both the integration efforts, as well as the impressive results that we've posted every quarter since the acquisition closed, to all of our hard-working and dedicated associates. Thank you. I look forward to building on what was a very successful quarter, continuing to grow our revenues, gain share and improve our operating margins.

I'll now turn the call over to the operator for Q&A.

Thank you, sir.

(Operator Instructions)

Rob Hansen, Deutsche Bank.

Last quarter, you gave EBITDA guidance of $50 million to $60 million. You came in a little bit ahead of that. I guess, what changed towards the end of the quarter? Was there anything that accelerated? What gave the upside versus what you were originally expecting?

A couple things. Generally, I would rather under-promise and over-deliver, so I'd like to always stay a little on the conservative side. And I think our sales growth probably ended on a little stronger note than we had thought. And as we disclosed the cost savings that we were able to realize, it certainly came in at or slightly above our expectations. So I think it was just a combination of those things.

Okay. And then exiting March and into April, how do trends look? Obviously, there's going to be a little bit of a drag from Houston. How do things look into May here?

It starts in the first quarter. We're obviously very strong, and so I would expect, you generally have a lag of starts before it becomes an opportunity for our business. So I would expect that to carry over into Q2, and create some incremental demand. Our backlogs at our plants are strong. So far, all things are pointing towards additional sales growth in the second quarter.

You're right. We had a lot of rain in a few markets, which made April a little choppy because the job sites were so wet, it really delayed -- or really, it eliminated our ability to get to some of the job sites for a couple weeks. So April was a little choppy, but we're still very optimistic about how things are lining up for the second quarter.

Yes. And we certainly are continuing to see a high level of builder confidence. Our people reporting from the field, still good business and building activity.

Does not appear to be slowing down, and I think we're right on the trajectory that we had anticipated, seeing in the improvement of housing starts this year. And we're seeing the housing start improvement over a broad range, over all of our areas. And there's no one particular part of the country that really is a lot stronger than others. We're seeing very, very good growth in all of our areas.

Great. One last one is just on the repair and remodel strength. That was an extremely strong number. Was this some sort of market share gains? Or was there a certain pull forward of demand, or something like that? How did that shape up? What's driving that?

I would agree with you. There were very, very impressive results in the remodeling area. In fact, I'm not really aware of any of the traditional repair remodel companies that came anywhere close to our type of results. But I think this is a reflection. Number one, we had, certainly, a not nearly as bad a winter quarter as traditional in our strong remodeling areas, which are the Midwest, Northwest and West Coast.

The other thing is, is that I think we're seeing the benefits of, we put money into improving our -- the displays and the product offerings in our locations. And this certainly is paying off, and I think it's really revitalized a lot of the markets for us. People are again recognizing that we are a good place to turn for their home improvement projects. And I think that's the reason for the real improvement in the R&R area for us.

Thanks, guys.

Jay McCanless, Sterne Agee.

I just wanted to clarify, on the $157 million in cash interest, when we're putting that into the model, we need to deduct the $7.8 million gain, which would get it to around, what, $148 million to $149 million for what you're going to show on the financials?

No, Jay, because you have to add in the unamortized debt non-cash cost of about $8 million, as well.

Okay, so those would net out.

Yes.

Okay, perfect. And then the second question I had, on SG&A, you were a little bit above what we were looking for on a dollar basis. How should we be thinking about that for the second quarter? And was there any other one-time -- or maybe not one-time, but items you don't expect to recur in the SG&A numbers from 1Q?

Nothing terribly significant. A couple of smaller things come to mind. But nothing that I think would impact your modeling, as far as one-time costs that hit the first quarter.

Okay. Okay. And then I was just going to ask, do you guys -- is there a range of adjusted EBITDA we should be thinking about for 2Q? And as I believe -- and also maybe you could frame any commentary you'd want to give around that versus what the pro forma numbers were last year?

I figured you'd back me into a corner, Jay. It's early in the quarter, but I'll do my best here. We commented a little bit on sales already. I think from a gross margin perspective, in the second quarter, I think it'll be similar to what we saw on the first quarter, somewhere in that 25% range. From an EBITDA perspective, last year, on a pro forma basis, we did right at $100 million. I think, as things sit today, I think we'll be somewhere in the $120 million to $125 million EBITDA range for the quarter.

Okay. All right. That sounds great. That's all the questions I had. Thank you.

Trey Grooms, Stephens.

Congrats on a good quarter.

Thanks, Trey.

So can you -- and I appreciate the color you just gave, Chad, on the EBITDA range and all of that. So for -- just to be clear, I know you talked about a little bit of color on sales, and how to think about the top line there. But -- and you talked about starts and the lag and that sort of thing.

If we were to take a look at the starts from last quarter, which were obviously very good, but then we combine that with a little bit of softness in April, or choppiness, as you called it, from weather and things. And then there will probably be some catch-up. Just not understanding exactly how quickly that catch-up can occur, any more color you can give us on how to think about maybe just the absolute volume number there?

And then I know you said, on lumber, that it should equal out this quarter, I think is the way I understood it, from a lumber impact. So any other color you can help us with on that front, to sort out the numbers?

I've looked at the consensus that's out there, and I think the consensus is a reasonable number for us in the second quarter, which I think is around 5%. So again, it's very early in the quarter, so I can give you my best guess now. It's probably somewhere in that 5% to 7% range.

Okay. Fair enough. And then have you -- so I guess trying to get a sense for what you're seeing on the labor front for framers and other skilled labor. Are you seeing any improvement there? Obviously, not for you guys, workforce necessarily, but more from a framer standpoint or other skilled workers out there. And also, do you -- with that, do you guys expect completions to continue to narrow at all, as far as the gap between starts and completions that we saw really come about last year?

Yes, Trey, the labor situation is still very tight out there. I think it is one of the major inhibitors against that really keeping and flowing down in the housing from even being better than the pace that we're currently seeing. We're also seeing tight labor within our operations; it's not just restricted to the jobsite.

It's -- we're finding ways to solve the problem, obviously. But it is much tighter than what anything that we've seen here over the past several years. I would say that it's not getting any worse out on the jobsite, but it is still very tight and it still is slowing down that house going from start to a unit completed.

Right. And I think there is some confusion out there, as it relates to that, and how that -- what that relationship is to your business. And Chad, you noted that there is a bit of a lag from the time you see a start to when you start to benefit from it, or start to see that business.

What is that lag currently, from a start to when you start to get folks out on the job site? And then has that -- I guess that lag is probably a little longer than what you've seen in the past, and how is that impacting things?

It is a little longer. Generally, a start is when they start prepping the dirt and they're working on the foundation, and then it becomes a unit under construction once the foundation is set, and that's when our opportunity for business arises. And so for several reasons -- it can be rain, it can be -- there's a -- in many markets, a delay in getting slabs poured. So [I'd say] it could be a two or three month lag right now, between a start and then a unit under construction.

And then the other thing you need to keep in mind, post acquisition, is we're about 25% R&R. And so that first quarter was a little unusual, as far as the growth we had in R&R. But typically, you're looking at R&R growth in the 3% to 4% range.

And so when you look at our new business, going forward, and you're just trying to baseline that off of starts, it would be very difficult for us, on a go-forward basis, to keep up with single-family starts as a consolidated company. Because we are heavily -- more heavily weighted towards R&R now.

Great. That makes a lot of sense. And then the last one for me is maybe a little bigger picture, longer-term thinking here, on the synergy guidance. The overall synergy guidance that you gave of $100 million to $120 million.

Where do you see the most opportunity for upside or downside to that number? As you -- because it seems like you're very confident in that number, so I wouldn't think there'd be a whole lot of risk at a downside. But given your confidence, just wondering where you could see the different levers moving that could create numbers outside that range?

Yes. I think you said it correctly. The downside risk I'd look at as very minimal. I think it's appropriate to talk about some upside in the -- the $100 million to $120 million was really what we expected to achieve in the first two years. Beyond that two-year window, as we get more of the Company on the one ERP system, I do expect to have additional cost savings that will primarily come in more of the back office functions, and the efficiencies we gain by being on one ERP system.

And so as we've talked about in the past, that's a three to four your process. So I think the upside to that $120 million is real, but it's going to be more of a year three or four, as we get on more of the Company on one ERP.

Okay, that makes sense. Thanks a lot for taking my questions. Good luck, guys.

Thanks.

Okay.

Will Randow, Citi.

Thanks for taking my questions. In terms of pricing for your non-commodity categories, could you go through that, in terms of drywall roofing and some of the other, I'll call it, ancillary products?

As far as changes in pricing?

Exactly. Yes. (inaudible) Correct, as well as the benefits you are seeing from procurement savings?

From the procurement savings, we've wrapped up our engineered wood RFP, and those results came in as we had hoped they would. And right now, we're going out to some of the other specialty products. Doors and windows, for example, those are currently in process. So that all feels like it's tracking as we expected. As far as price increases we've seen this year, I think most of the windows and doors guides are somewhere in that 5% range, I think, on average.

Got it. Thank you for that. And then as a follow-up, you mentioned the flooding in Houston. Obviously, there was also a fair amount of storms in North Dallas. Have you seen any benefit in April or May from that inclement weather?

It's still very wet. And so those markets that you just mentioned, I would say construction is still lagging a little bit, as the lots are drying out. But we have had a break in the rain the last week or so. So I would expect that to start picking up more in the coming weeks.

Yes. And anything -- you don't lose business by the wet weather; all it does is push it out. And we definitely are seeing now, when -- as things are drying out, and we're definitely -- the shipping schedules are rapidly picking up. And it will -- all it does is move a little bit further out for us, but the business is there.

All right. Thanks for that and good luck in the next quarter.

Thanks.

Nick Coppola, Thompson Research.

Can you add some more color on what your thoughts are around lumber pricing? And [it was] certainly nice to see the rebound in recent weeks that you've talked about. I guess what are your thoughts around pricing? And what are your go-forward expectations?

Certainly, and my feelings are is that we will see a slowly improving lumber pricing, lumber, lumber sheet good pricing. We certainly are experiencing that now. If I look at over the last eight weeks, and do it on an eight week average, comparing this present time to last year same time, then we're seeing -- we've seen an improvement that's about 5%, a little over 5%.

The last four weeks, it's almost like a 6% improvement over the same time last year. I think this is -- the market is really starting to correct itself. I don't see a runaway market in pricing, but I can see a continually improving situation for us.

The mill capacities are coming up. We saw one recently, it was in their earnings report, one of the major OSB producers are now up to a 93% capacity. I suspect many of the manufacturers are getting up into that high 80%, low 90% capacity.

That can only mean -- there's going to be no real new mills coming on stream that I'm aware of. So that means I would expect to see a slowly improving pricing. And I think for the rest of the year, we'll probably be in an inflation mode versus last year. And I think that's going to be somewhere in that 5% to 10% improvement over last year, over that period of time.

And I think we're going to see -- continue to see, into next year, as long as housing continues to improve, which our feelings are very much that it will, we don't see anything, certainly, at this point that's going to cause housing to slow down or falter. And we see a continual gradual improvement in housing.

We think all the elements are there in place to support it. And I think the mills in the future, as we go into the future, I think we're going to start seeing lumber, lumber sheet good pricing get back to a more -- the normal level of pricing that we saw back in the 2005, 2006 period of time.

Okay. That's helpful. And then shifting gears a bit, can you just talk about any weather benefits in the quarter? And so likely something difficult to quantify there. But apart from the flooding you talked about, there was also unseasonably warm weather in a lot of the regions in the country. And so what was the benefit there. And do you think there was any related pull-forward demand?

You're right. Some of the major flooding we were talking about, Houston in particular, was an April event. So that wasn't a first-quarter event. In most markets, the weather in the first quarter was much better than it was a year ago.

Yes, it was a much milder winter.

Yes, and less snow and ice. And so I think that's why you saw the 22% increase in starts. And that's why our demand in the first quarter, to some degree, was stronger than we had expected, and some of that was weather driven. So I think overall, it was a very favorable quarter, from a weather basis. It was more April where we got the negative impact.

But we're seeing the level of housing activity, and what builders are projecting and planning for the coming months, is staying right on that pace that we think in 8% to 10% (multiple speakers).

Yes, and I would expect the benefit in first quarter was more catch-up than it was pulling the business forward. That's what my gut says.

Okay, that makes sense. Thanks for taking my questions.

Yes.

Matt McCall, BB&T Capital Markets.

This is Reuben in for Matt. So you gave free cash flow guidance in the same range you gave before. I just wanted to make sure I understood the components.

You beat on the EBITDA side in the first quarter, and you've got lumber moving in the right direction. I just wanted to see if I -- and it seemed like D&A was a little higher than we thought in the quarter. So I just wanted to see if you could run through the components for this year? And maybe offer any insight as to your outlook on cash flow for the next couple of years?

The major pieces are going to be whatever you want your EBITDA starting point to be for the year. But I think CapEx will be around 1.5% of sales. Cash taxes will be minimal, $5 million to $6 million. Working capital -- and I would refer you to slide 11 in the presentation -- working capital would probably be in that 9% to 10% range, on incremental sales. And then cash interest in that $157 million range. So that should get you somewhere in that $75 million to $85 million of free cash flow this year.

And as we pointed out in the opening comments, as we get deeper into next year, and we get the one-time costs behind us and get full realization of the cost savings, those two things right there would add another $75 million or so in free cash flow, even assuming a flat housing environment. So that's why we made the comment earlier that once we get those items behind us, we would expect free cash flow to pick up even more.

Okay. And then how much of that will go towards just sheer debt reduction? And then can you just update us on what your thoughts are on the net leverage for the next couple of years?

It's hard to say exactly how much it will. It will depend on the opportunities we have to attack the debt. But we're going to continue to be aggressive at it, and look for opportunities. I would expect by the end of this year, we should be well below 5 times levered. And then by the end of 2017, we should be well below 4 times would be my estimate at this point.

Okay, and then one last one. You, in the past, have given a full-year or incremental margin target on the EBITDA line of about 12% to 15%, I think you said, ex-synergies. And this quarter, you just did at the -- did about 19%. Can you -- does 12% to 15% for the full year still make sense? And --

I think it still makes sense. We had year-over-year gross margin expansion, which certainly helps your flow-through. As we get deeper into this year, as we alluded to earlier, we won't have the benefit of commodity deflation. And so some of that -- the benefit of the gross margin expansion will probably go away. So I still think we will end up, for the year, somewhere in that 12% to 15%.

Okay. Thank you.

Ladies and gentlemen, we have time for two more questions. Mike Dahl, Credit Suisse.

Thanks for taking my questions. Wanted to go back to -- I think in response to Will's question earlier, about procurement. And I think you outlined, engineer wood RFPs complete, doors and windows in process. Just wanted to confirm, first. So is engineered wood the only one that's complete, as far as the supplier reviews, at this point? And then could you just talk us through the timeline for some of those other big categories, once doors and -- when are doors and windows going to be complete? And then some of the other areas?

On a daily basis, we're obviously going after our suppliers on price, and in using the benefit of our scale. But when you start talking some of these specialty products, and there's fewer suppliers that can serve you in all your markets, and so those were a much more structured RFP process. I believe we've also completed wallboard, and as I said, windows and doors are in process right now.

Those are going to be your major categories, where we'll go out and do full-blown RFPs and have a structured process around that. But the other categories, we're chipping away at a daily basis. And in some of those categories, you really don't put in one, two year pricing or rebate type programs. Those are more just taking opportunities that are available in the market at the time you're going out making buys.

Okay. Got it. That's helpful. And then shifting gears to the sales side, just some of the category sales. So if I look at gypsum, roofing and insulation, up 6%, I think if you look at some of the other industry players, either your peers or your suppliers, seeing some numbers well north of that. So curious if you could give any color on what you were seeing in those areas? And do you think you were -- how do you think you fared relative to the market, in terms of end demand?

Yes. I think for us, in our markets, most of our -- the roofing and the gypsum products are going into single-family remodeling projects. We're not really doing the larger commercial projects that drives, and certainly that is a driving factor for some of the other companies who are reporting, who are pure play roofing guys or gypsum guys. I think our market performance for those products was very good.

Could it be better? Yes, and we're working on that. We're also expanding some of the areas, and adding some new areas, to help drive our results in those products. We like those products. They're a good contributor to our overall package, and they certainly have a lot of attractiveness to us for the future. And so that pretty much sums up all I can say about the products and the performance in the first quarter.

Okay. Thank you. Then last question, just maybe another clarification, and Chad, for you. Just going back to the debt reduction comments from before, I think there's a footnote in the slide on interest forecast that's talking about excluding an annual principal pay-down of $5.5 million. Just want to confirm, that's just your normal -- a normal annual required pay-down, and not a comment on -- that you only expect to reduce principal another $5.5 million?

That's correct. That's the required pay-down.

Okay. Great. Thank you.

All right, and ladies and gentlemen, we have time for one more question. Dillard Watt, Stifel.

Thanks. Most of my questions have been answered. Chad, maybe just lastly, if there's any way you could break out the gross margin improvement? I know you broke out the three buckets. Was there any one that was more material than others?

And then secondly, related to that, is the commodity price deflation, is that all related to lumber? Or were there some other benefits related to maybe fuel or energy costs?

I think we have about a $1 million or $2 million favorable variance on fuel, quarter over quarter. I can't think of any other commodity products where it would've been meaningful. As far as your other question, on the margin enhancement, I would say probably -- I would say those three are fairly evenly spread on the margin improvement. Probably about one-third, one-third, one-third would be my best guess.

Yes. I think it was pretty much spread across all of the major value add categories.

Yes, and we probably got about a 30 basis point tailwind on the margin, of the 90 from deflation.

Got it. Simple question, simple answer. Thanks, guys.

All right. And with no further questions at this time, I will turn things back to Mr. Sherman for any closing or additional remarks.

Okay. We appreciate everyone joining the call today. We look forward to updating you on the progress of the integration and our business initiatives in the months ahead. And if you have any follow-up questions, please don't hesitate to give Chad or Jen a call. Thank you, and we hope you have a good day and a good weekend.

And ladies and gentlemen, that does conclude today's conference. Thank you for your participation.