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Builders FirstSource, Inc. (BLDR)

Q4 2018 Earnings Call· Fri, Mar 1, 2019

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Transcript

Operator

Operator

Good morning and 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. And now it's my pleasure to introduce Mr. Binit Sanghvi, Vice President, Investor Relations. Please go ahead.

Binit Sanghvi

Management

Thank you, Laurie. Good morning and 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 and instructions will follow at that time. Any reproduction of this call, in whole or in part, is not permitted without the 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 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. Chad Crow.

Chad Crow

Management

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. Then 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 2, 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 3, 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 and value-added products capacity by helping our customers solve challenges like increasing cost, 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…

Peter Jackson

Management

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 goods prices declined 39% and 32% respectively compared to the beginning of the third quarter. As a result, our gross margin percentage improved as cost 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 to 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…

Chad Crow

Management

Thank you, Peter. Moving to slide 11, although the housing market in starts growth have moderated over the last few quarters, we remain confident in the fundamental underpinning of homebuilder 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 in 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 to $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…

Operator

Operator

Thank you, sir. [Operator Instructions] And going first to Matt Bouley at Barclays.

Matt Bouley

Analyst

Good morning. Thank you for taking my questions. Congrats on the quarter and on reaching your leverage targets as well.

Chad Crow

Management

Thank you.

Matt Bouley

Analyst

So I guess on that point with leverage down near three 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.

Chad Crow

Management

Yes, I think it will be a little of both. I -- we want to continue to delever. As I've mentioned in the opening remarks, we certainly want to expand our value-added platform. And so if some opportunities came along there to do so -- to buy those greenfield, we would certainly look at it. At the present time, I don't anticipate any significant M&A. But certainly, we would consider some smaller M&A options from a value-add standpoint as opposed to greenfielding. Greenfielding 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. So I would certainly be open to some smaller M&A activity and at the same time continue to delever a bit.

Matt Bouley

Analyst

Okay. I appreciate that. And then 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.

Peter Jackson

Management

Yes. So the discussion around SG&A obviously you saw the jump in the percentage. There's couple of factors obviously as we deflate there'll be some natural inflation. Just like we saw the benefit in the earlier months in 2018. But we did see commissions go up. And hopefully that was a clear explanation and that we are -- our commission plans are built to reward our salespeople for selling at higher margins. And so that award 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 benes is certainly an area where we've seen pressure over the last year unemployment is down. And we certainly had to work to take care of our employees and make sure that we have good retention. And 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. So some areas there where we have -- and we'll likely continue to see some challenges with inflation. But the team is doing a good job of managing expenses and staying discipline particularly in the controllable areas. In 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 is important to remember seasonality though, right? So 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.

Matt Bouley

Analyst

All right. I appreciate all of the detail. Thank you.

Operator

Operator

We'll go next to Nishu Sood at Deutsche Bank.

Nishu Sood

Analyst

Thank you. So the sales per day guidance implies -- for 1Q 2019 implies that you're expecting -- once you factor out the lumber price. So in the commodity inflation drag about mid single-digits gains year-over-year and 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. So is the -- has the book of business, has it seen any effects from that for you folks? And 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 1Q 2019 versus some of the other data points we're hearing from some of the public builders?

Peter Jackson

Management

Yeah. So I guess I'll start and of course Chad can jump in. The components there in - I would say our expectation is more in the low-single digits increase particularly for single family. There is growth in the business. We've got, of course, a little bit of share that we think we've got a line of sight too. Perhaps a little bit of rounding in some of the number 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. And we think those encouraged homebuyers to get back in the game as things settle down a bit. The pause that we expected we think is just that pause and things will get back to a more normalized level or perhaps slower growth than we've seen in certain points in the past couple of years, still growth. So a lot of optimism out there and despite some lumpiness whether it be weather or a pause we saw a lot of confidence in the underlying demand.

Nishu Sood

Analyst

Got it, got it, okay. And 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 I should -- I love your thoughts on that whether that's still the case. So 210 basis points above "normalized" how much incremental sales commission did that drive in basis points?

Peter Jackson

Management

Let's see. So 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. So it's substantial amount…

Nishu Sood

Analyst

Got it, got it. And as the -- as we think about this commission I mean it -- was it larger because of the extreme volatility? So the incremental sales commission against where prices were -- I mean I used the benchmark of that 25% normalized gross margin. But does the commission work that way? Or is it against improvement in gross margin so that the extreme volatility might have had a greater effect and pushed those sales commissions on stronger margins up more than they might've been on a normal volatility environment?

Peter Jackson

Management

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 it -- when we see inflation, the profitability goes south, we both reward and penalize our sales people for achieving higher profitability and lower profitability, respectively. So that net 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?

Nishu Sood

Analyst

No, that's great. Thanks very much.

Operator

Operator

And our next question is from Trey Morrish at Evercore ISI.

Trey Morrish

Analyst

Thanks very much guys. And really good quarter. I want to talk a second about the margin trajectory outside of lumber. So we understand that lumber can have quite a bit of volatility just given the massive pull down. But could you give us some thoughts some insights on what your gross margins outside of the lumber category looks like? Were they also up as well? Or were they kind of more flattish?

Peter Jackson

Management

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 we have we were able to drive for the year probably about $4 million worth of benefits in those initiatives and a lot of that was in the fourth quarter.

Chad Crow

Management

And I'll just add we did see some improvement in the manufacturing 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. So 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.

Trey Morrish

Analyst

Okay. Got it. Thanks for that. And then turning back to the volume outlook that you're looking for 1Q. You said it was kind of low single-digit range. But this point we're two-thirds of the way time-wise through the quarter, maybe not quite business and sales-wise. But would it be fair to extrapolate from your comments that you're probably tracking flat to probably up so far year-to-date?

Peter Jackson

Management

I don't plan to change my guidance and I think we'll make the guidance for the quarter.

Trey Morrish

Analyst

Okay. All right.

Peter Jackson

Management

If that is implied, right. I mean, yes. Thank you.

Trey Morrish

Analyst

Thanks.

Operator

Operator

We'll go next to Mike Dahl at RBC Capital Markets.

Mike Eisen

Analyst

Good morning. Mike Eisen on the line for RBC. Just wanted to start off on the value-add products you guys continue to invest and then 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 reaccelerate that and continue to grow outside in that -- in those segments?

Peter Jackson

Management

Yes. It'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's still a lot of demand for the value-added product, right? There's – despite, again, all of the terrible headlines the demand hasn't really gone anywhere it's still there. And so the availability of labor the job sites being -- 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 products. 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 heavier days last year when the overall market was growing at a high rate, but we still anticipate healthy growth through 2019.

Chad Crow

Management

Some of it could be regional too. A lot of the heavier used regions of the country over the Pacific Northwest and the Northeast and those tend to be impacted a little more about weather then say Texas would -- isn't impacted as much, but also is as much of a truss market.

Mike Eisen

Analyst

Got it. That's really helpful information. And then transitioning to your delivery optimization program. You guys laid out some early successes you've had and desired 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'd be better SG&A better throughput? Something that we can help quantify the magnitude of the potential here?

Peter Jackson

Management

Yes, sure. So we are looking that number for 2018. Still early days in a lot of locations, but really positive feedback from the users and those that have really adopted it and started to see 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 cost as well as SG&A in some of the overhead costs. We think that we saw -- and we 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 manage 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-phased approach for each location.

Chad Crow

Management

And I'll just add. In total we see it as a company over the next several years is somewhere around $20 million to $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 say it in another way somewhere around 30% basis points as a percentage of sales. So it's a real opportunity and I feel very good about being able to achieve those numbers in the coming years.

Mike Eisen

Analyst

Got it. Thanks, good luck.

Chad Crow

Management

Thank you.

Operator

Operator

And we'll go next to Jay McCanless at Wedbush.

Jay McCanless

Analyst

Thank you. Good morning everyone. So my first question if lumber prices stay where they are in now, theoretically should we expect some deleveraging on the overhead margin just assume we stay like in this 350, 400 band for the full year?

Peter Jackson

Management

Of course. Yes I mean it's -- we think it's going to work on an adverse way as last year. The growth in commodities benefited us on SG&A as a percentage of sales when it was inflating. And as it deflates, it will go the opposite direction. We didn't add people for example when it inflated so we won't take people out when it deflates. But underlying that I think we're very pleased with the fourth quarter results. There were some skepticism if you recall Jay in the market about whether or not we'll be able to protect our margins in case of deflation, and whether or not we would see the outsize benefit in our gross margin percentages that we claimed. And I think our results certainly proved that we did what we said we would do. And so we'll manage through this year. There'll be some continued volatility commodities always manage to throw us a curveball or two. But I think we're very well positioned. We've proven our discipline and our ability to manage in both up and 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.

Chad Crow

Management

Yes. And I'll just add. I don't think I'm going out on a limb to say, its 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. But even, that being said, it's likely going to be a bit of a headwind this year. But all in all, as you guys -- everyone knows on this call, we operate in a cyclical business. And this is just part of it. And in a cyclical business, you have good years, you have bad years. 2018 was a good year and despite maybe some additional headwinds in 2019, 2019 is going to be a good year. So as Peter said, we will deal with what comes our way. But we feel really good about things as we sit here today.

Jay McCanless

Analyst

The second question I have with the excitingly bad weather we've in a lot of different locations this year. I'm assuming that the guidance you've 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? And then also the other one I want to sneak in on the -- could you repeat, and I missed this, so I apologize. But just how much of the 2024 notes you guys bought in, both in 4Q and then this quarter?

Peter Jackson

Management

Yes. So to answer the second question first. It's about 75 total, 50 in Q4 -- 50-ish in Q4 and 25-ish in Q1. Yes. I mean, I'll make a couple of comments on the weather. I mean, first of all, definitely not a benefit. I'm assuming you were being facetious on that one. A lot of destructive weather, a little bit in the fourth quarter, more in the first. We -- candidly, we don't like getting into the weather reports, but you having heard other folks talk about it, it absolutely is real. Polar vortexes, blizzards, unusual snow in the Pacific Northwest, unusual rain in the Pacific Southwest. So it is certainly an interesting time. Yes, we've included the bulk of what we've seen so far. But I can't say tomorrow's weather pattern is focused in. We'll, have to respond to that, but 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.

Jay McCanless

Analyst

Sounds good. Thanks guys.

Peter Jackson

Management

Thanks, Jay.

Operator

Operator

And we'll go next to Matt McCall at Seaport Global Securities.

Matt McCall

Analyst

Thank you. Good morning, everybody.

Chad Crow

Management

Hi, Matt.

Peter Jackson

Management

Good morning, Matt.

Matt McCall

Analyst

So the -- that 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, I mean, how do we think about 2019 relative to that 85%?

Peter Jackson

Management

Yes. So it's a good question. I mean, part of the reason for not giving guidance is because, depending on where commodities goes there goes my both EBITDA and there goes my working capital, likely in different directions. Same is true with single family starts. The rational for the change is, people got hung up candidly on that long-range plan presentation with regard to the accumulative cash flow and kept trying to lock back to -- so what year and what year. And our point in that is, really to emphasize a normal housing market has a significant tailwind from where we are today on our results. And over time, our performance -- improving performance really thinks back very well to that sort of 85%. Some use more, some use a bit less, but running in that 85% range historically and going forward for cash generation that we can utilize, right, to grow the business to pay down debt, continue to strengthen our balance sheet. So we felt that was a more appropriate way of talking about it, rather than a single dollar amount over a cumulative number of years. So that was a rational for the change. As we get into a full year guide, we can add that sort of list to providing to everybody that percentage for the year.

Matt McCall

Analyst

Okay that's fair. I understand the uncertainty around what lumber does. So I think in the past you talked about 9% to 10% working capital, 9% to 10% in 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?

Peter Jackson

Management

I would say, generally it is. But you have to account for the lumber volatility as of -- as an impact as well, right? And if you can tell me what my volume is and what commodities we'll do? I can tell you what my working capital impact is going to be.

Matt McCall

Analyst

Okay. I'll work on that. So, 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. What's -- do you have a new target established? Or you just continue to work it down in the absence of an opportunity from here? Where -- how do we think about your net debt-to-EBITDA bogey?

Chad Crow

Management

Yes. It depends, right? It depends on how we're feeling about the cycle and where we are. It depends about -- 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. We back in 2015, we had no idea ProBuild would come along. And I'm being glad we did it. So it really just depends on the opportunities that are out there. But I would say, bar any significant opportunities that we want to look at. Yes, I'd say, driving it down somewhere closer to 2.5 on a longer-term basis is probably what we'll be looking at.

Matt McCall

Analyst

Okay, perfect. And then, last one, I think, you broke out the CapEx, it's going to be aimed at kind of new facilities, some of the truss -- if you see truss facility, more 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 to either each one of those or the total?

Peter Jackson

Management

We called that about a quarter of our CapEx, another quarter of the 1.5% we think will be focused on those categories that I think you are outlining there.

Matt McCall

Analyst

And how does that -- what was the total in 2018 in those terms? About the same?

Peter Jackson

Management

That's a good question. Probably about the same, maybe a little less, but right in there.

Matt McCall

Analyst

Okay. All right. Thank you all.

Operator

Operator

Moving next to Steven Ramsey at Thompson Research Group. Sir?

Steven Ramsey

Analyst

Good morning. I would assume …

Peter Jackson

Management

Good morning.

Steven Ramsey

Analyst

… just thinking about your locations sort of on a portfolio basis as you continually access 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? And kind of 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 bases or where you want to be?

Peter Jackson

Management

So, I guess, I can open it and then sure Chad will probably want to jump in. But the decisions about opening and closing facilities in the given year, yeah, we opened I think two this year and closed two this year. So, 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 about -- 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 got a location it starts to run up against capacity constraint, 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 around the lumber side. Your footprint matters or things you can do to improve efficiency, but there is some real space constraints that will limit the amount of dollars you can put through a facility. And that falls into the decision-making. 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 EBIT basis, but 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.

Steven Ramsey

Analyst

Great. And 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? And is your outlook from today thinking about 2019, is it more predictably good? Are you able to kind of quantify range on growth in that end market than you are with new construction?

Peter Jackson

Management

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 on to 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 soybean's important 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 is I'm sure everybody knows very volatile market historically. That's proven true in the last couple of years as well, so I'm a little reluctant to call a ball on that market, as well. And then unfortunately, Alaska despite the beginning of the recovery in oil prices in the fourth quarter are sort of pullback a bit. So we are -- there is a bit more wait and see up there as well. So, I'd say those are all reasons for uncertainty, not reason for optimism at this point, but we're going to wait and see.

Chad Crow

Management

Yeah, I don't -- 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. So, I would echo what Peter said. Don't say it going gangbusters. It could be a little sluggish this year.

Steven Ramsey

Analyst

Great. Thank you.

Peter Jackson

Management

Thank you.

Operator

Operator

And we'll go next to Kurt Yinger at D.A. Davidson.

Kurt Yinger

Analyst

Yeah. Good morning everyone and thanks for taking my questions.

Peter Jackson

Management

You bet. Yeah.

Kurt Yinger

Analyst

I just wanted to start off on going back to gross margin. I did my math right. You're looking for 26% or maybe a little bit better in the first quarter. And 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 a lot -- about 100 basis points quarter-over-quarter in the first quarter and the same in the second, or is it may be more of a gradual step down?

Peter Jackson

Management

Generally what we've said in the past and I think it's true still now is it -- it takes about a quarter or two to work through inventory on the ground and the pricing arrangements we have with our customers. So, I would say given that price has started running back up in Q1. Q1 and Q2 is where you're going to see the vast majority of the impact.

Chad Crow

Management

Yeah, I think it'll pretty much have played out barring some unexpected change by the end of Q2.

Kurt Yinger

Analyst

Okay. Very helpful. Thanks. And looking at the $65 million to $75 million sort of improvement now 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?

Peter Jackson

Management

I would say it's probably a third margin, two-thirds SG&A.

Kurt Yinger

Analyst

Okay. And lastly, what's a good way to think about interest rate -- interest expense for the year?

Peter Jackson

Management

Yeah. So, our guide is about $95 million to a $100 million.

Kurt Yinger

Analyst

Okay. Thanks very much.

Chad Crow

Management

You bet.

Peter Jackson

Management

Thank you.

Operator

Operator

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?

Chad Crow

Management

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.

Operator

Operator

And ladies and gentlemen, once again that does conclude today's conference. And again, I'd like to thank everyone for joining us today.