Robotti Fireside Chat with Peter Jackson, CFO, Builders First Source

Yeah, no, happy to do it, Bob. Thank you again for the opportunity to talk with you and your crew about what we're up to. I think the history of Builders FirstSource, in terms of the way that we combined initially with ProBuild and then ultimately in 2021 with BMC, has really created a company that is uniquely positioned to partner with home builders. Our size matters, our coverage matters, but also the product portfolio. That was an area that, early days as you described, coming through the Great Financial Crisis and growing out of the 2010s era, was really an attempt to lean into where we could add value for builders. In many ways, it started with trusses, roof trusses in particular, but has really spread through the business in terms of different products that we offer and certain services that we offer as well. It's really focused on helping the builder be better at the art and craft of home building. It's certainly a catchphrase for us internally and externally in our marketing materials, but it's really about helping the builder be more efficient, more profitable, and even more importantly, it's that exposure to value-add and the ability to capture incremental margin from that. So while we're helping our customer, we're also helping ourselves.

I think that's a fair characterization. The opportunities come from single-family traditional, single-family rent-to-own, or even more recently the multifamily space in apartment buildings. Generally, for us, that means five-story below wooden structures. We're not generally talking about high-rise towers of any sort. You're right that that is an opportunity that we've pursued. We've looked for ways to buy and focus on buying companies not only that help grow our geographic expansion but most of the time that are very focused on those value-added offerings. Over the past couple of years, that's been multifamily truss. There's been a lot of truss over the past few years, but in general, that's an area that we lean into.

No question. No one is doing it like we are. No one has leaned into it like we are. Certain of our competitors in the space have dabbled in it, and we think we can not only maintain and extend our lead in the core product offerings, but we think there's a lot of service offerings that come along with that, whether it be install or digital.

You're right about that, and there certainly has been a lot of discussion. I think there are two main points why it's a different business model now than what they dealt with back in the Select Build or the days when it was really an overhang. The first of which is it's narrower. For the most part, we're not trying to offer services outside of our core product offering space. For a while there, there was a lot of different things. Now it's really focused on the products we know best: framing, windows, and even some market stucco, because it's something we've done for a very long time and we have a lot of experience in the space. The second piece of that is the continued lack of skilled labor versus the number of starts that we have in this country. That has continued to put pressure on available trades and allowed us to step in and say, 'Look, we have relationships. We can make the life of these trades better by maintaining the relationship, by running the business component of it. We can put a lot of business in front of them in a very consistent way over time.' Our balance sheet is impervious, so there's never any question as to whether or not we can pay them. We have the relationships in the areas where builders really need those trades, and having the good business model to be able to provide that, we think that's what's made us the preferred partner for builders and a really nice option for the trades instead of trying to run their own business, leveraging our relationships to keep themselves busy and profitable.

We started in 2017 talking about what opportunities did we have as Builders FirstSource to leverage technology and really differentiate ourselves on that side of the fence. There hadn't been a lot of investment in the industry broadly, and where there had been investment, I would say it hasn't been very successful in terms of utilization. What we saw were a lot of individual point solutions, things that people were doing that were valuable within a narrow band. Renderings were pretty interesting, people were using them. Some people had some scheduling tools, some people had some things they were doing with the digital twin. But there really hadn't been a way to bring it together in an end-to-end platform. We saw that as an option, but ultimately it needed to be anchored on that digital twin mentality, that true plan, that truly structurally buildable plan rather than the architect's concept that would really drive the build process. Master plans, real quality, usable material by the builder and the trades and by the vendors like us. That was really the impetus for the Paradigm acquisition. They had some technology at their core. They had done some really nice configuration work around the doors and windows space, and we saw that as something that could be scaled to something that could be expanded. When we partnered with Paradigm in the early days around estimating, we saw a real opportunity there. So we acquired them in the middle of 2021, and over the past couple of years we've built out that idea, that concept, the idea to leverage that configuration tech to the broader configurable home based on that three-dimensional digital twin. The most powerful aspect of that is where we integrate that, we connect that into the BFS offering, meaning it's a truly shoppable plan, a shoppable digital twin. So when they see that they want to build this house, and we have the estimate of what the bill of material is, whether it's a third car in the garage or specific selections like 'I want the Hardie siding' or 'I want the traditional siding,' 'I want the metal roof or the asphalt roof,' you can make those selections and in real time get updates to the quotation. You can do that because this is the true structure design, has real measurements, real intelligence around it. Of course, those offerings are delivered by BFS, so then we can tell you when it's going to be delivered, we have a schedule, and you can pay your bills online and do all of those things in one integrated platform. That's been the build, that's been the heavy lift over the past couple of years, and we finally finished the MVP, the minimum viable product, and then the beta, or I guess vice versa, the beta and then the MVP. We're now in the process of rolling that out to the market. It's a very powerful platform for the home builder to have really an end-to-end control around their plan, the way the subs work together, the schedule that they're going to execute the build on, and then powerfully for us, of course, is the ability to allow the customers to shop for the products necessary to build the house. Initially, it's just our stuff, it's just what we've baked into it, but we've got two or three thousand SKUs in there and that number increases every day. We think that's something that over time will be pretty compelling for builders and for vendors as well.

I think there were a couple of reasons why both were differentiated and there's a stickiness to it. I think the biggest differentiation goes back to that comment I was making before about point solutions. Specific examples: you've got folks out there that do renderings. What that means for the uninitiated is that you take an architect's two-dimensional design, you send it over to basically an artist, and they turn it into a three-dimensional rendering. The problem with them though is they're not actually buildable. They're the artist's vision of what this should be. Someone's turned it into a CAD design, but it's not what you're actually going to build. What folks actually build is what we do. We see 350,000 plans a year already, helping customers come up with their bill of materials for the structural design of the home. Having the partnership where we're doing the trusses for them, providing them in many cases sealed plans for the trusses, helping them with the bill of material, and then ultimately the decision making about exactly how that ceiling is going to look, that's what we do. And this is what you're really going to be able to order because the specificity of the plan is truly aligned with the structural design. Powerfully, it is a connecting function through the rest of the build process. Builders have control, but they can decide who can see. They can assign the plumber, the electrician, the HVAC person, as well as the framer to have access to the plan. Real-time markups allow them to put notes on mistakes or issues long before the build gets completed. Conflicts, concerns, issues can be identified and shared with one set of plans as opposed to 'here's your set, plumber, here's your set, electrician,' both of you are wandering off with plan sets that are different. That's a skill set that no one else has come anywhere close to. Then when you layer on the shopability of it and the scheduling, which brings all of those players together with the materials, 'here's when the framer needs to be there, by the way, here's when the delivery is going to be there,' it's very powerful in terms of keeping the builder efficient, connected, and very professional. All this, depending on the builder's discretion, can be shown to the home buyer. They know where they are in the schedule, they understand what the plan looks like, and then the home configure functionality that allows the selections you had talked about previously, the metal roof, the asphalt roof, what it looks like, and all of it is tied to the actual structural design. It's very powerful.

As usual, Bob, you hit the nail on the head. That's where I think the real challenge is. There's no question in my mind that technology is the right answer. I'm very optimistic, but I don't want to be overly excited because first movers and early adopters are usually excited about cool tech, and we have the cool tech. Where I think the challenge lies is getting all of the individual players, the folks that are already trusted to make sure the homes are done right, to be engaged in this. In my world on the BFS side of the fence, that's the OSRs, the outside sales reps, the ISRs, the inside sales reps, the support folks, the ones that are dealing with the builder every day with their frustrations and changing the schedules and changing the order and getting the pricing. Those teams, along with the estimators and designers, need to be integrated. They're integrated today because that's how we do business, but we need to get them trained, get teams up and running, and make sure they have what they need. Not only improving the software that we're offering to our customers but also what we're using internally on the BFS side. That's step one. Step two is making sure we have the resources necessary to support what builders want to do. We talked about all those SKUs that we have available from our product portfolio that we have in the tool, but if you're a builder, you may not want to sell metal roofs. 'I don't do that. I only want to show asphalt roofs, and by the way, I only do these two brands because those other brands aren't good.' Helping them to curate their catalog that's displayed to the home buyer so they can only pick from what we want, we have that. That's some of the support that we need to provide. The third thing that I think is really important for folks to really like about this tool is what we call Home Optimize. This is where our people are working with the builder team, generally the framer as well as at least a handful of the subs, to be able to build the house virtually before you get to the job site. You find the conflicts, you find those points where the electrical and the HVAC are in the same chase within the home, and you fix that before you get to the job site. We've gotten really positive feedback about the efficiency that that creates, the conflicts that it resolves ahead of time, and ultimately the money that it'll save builders, both large and small, if they take that approach. Again, something we're offering that no one else is.

Absolutely. You hit the nail on the head. The first piece is the value-add product offering itself. Our customers have options. You can buy a door slab from us, but why would you when we can give you a pre-hung door? Yes, you can buy dimensional lumber, but why would you when we can sell you a roof truss or ready frame or wall panel, whatever the option is that's best fit for you as a builder? The second piece of that is the coverage. It's great that I sell it, but if I don't sell it near you and if I don't have capacity to be able to provide it near you when you call, that's a lose-lose situation as well. We've invested tremendously in the past couple of years, over $130 million in incremental capacity in millwork, as you described, and in that space to increase our ability to have capacity. We certainly suffered like everyone else during the COVID supply chain disruption and not being able to do as much as we needed to do. We've leaned in really hard over the past couple of years to make sure we're ready for the next run. We're confident that the investments we've made will help us be a far better partner. The third thing is linking it to the salesperson. That expertise is unique. Those relationships matter, the experience matters. Our subject matter experts in all sorts of different areas of the business, whether it be engineered wood, design, even siding, we're exceptionally skilled in that area. When you combine all three of those things, you get a differentiated service. When the customer picks it and they want it, we have the facilities and the wherewithal to deliver.

I think the most obvious stuff is familiar to everyone. It's what we already do today. It's taking advantage of our skill sets in markets where we do it well and expanding it to markets where we don't. We're very good at pre-hung doors. We don't do it much in the Phoenix market, so we're leaning into expanding that. The Phoenix market we started with an acquisition of Pima in 2021. That's the type of thing that we'll continue to do, continue to leverage our foothold with customers to expand the product offer. But within the tool itself on the digital side, it gets very interesting because you can start to take advantage of some of the functionality that's available. For example, if you go to your favorite home improvement retailer and you want to buy a window, more likely than not they're going to utilize Paradigm software to help configure that window. So when it's ordered from your favorite window manufacturer, it's buildable and it has a price and it's what the customer wants. Well, that's not baked into our tool yet. We haven't gotten far enough along in our evolutionary process to have the button so you can hop out to the window config tool, but that's certainly doable. That's well within our control. We plan to, that's on our path of further development. Similar to doors, that's the most obvious stuff that we can do. Doing a round trip with our truss process, leveraging that digital twin, is far from done.

You're right about ready frame being one of those great ideas that has struggled to get a lot of adoption. I think the digital environment changes that. There are more opportunities to put it in front of home builder customers and give it as an option than you would in a manual process. The efficiency that comes from utilizing the tool gives you additional bandwidth and capacity to do that work. Putting it in a digital environment allows for that radio button option: 'Would you like the dimensional lumber, would you like the fully prefabricated wall panels, or would you like ready frame?' That starts to become a reality in that digital space. I certainly believe over time there's an opportunity for take-up. We don't have any models around that or estimates around that, but I think the digital environment is a game changer for ready frame. Historically, having those disconnected through all the trades meant that the end result of the home that was constructed was different in some important ways than what people expected when they did the original design or even had one of the versions of the blueprint. Having a real-time digital twin starts to change that and really opens the doors to off-site fabrication in a way that wasn't accessible before.

I would say maybe an example is the easiest way to describe it and then talk a little bit about why we think we're uniquely positioned to benefit. Historically, you're right, framers were hired as a sub. But I would go back to this: maybe the smaller builders, many times the contractor is the builder. They were the ones who learned starting with framing how to build a house. That's traditionally how it worked. A framer would make $8,000 on a 2,000 square foot home to frame it from stick. That's an $8,000 value to them. They have a certain number of crews that they would assign to that, but that's how they envision it. That house is worth $8,000. Well, if we show up and say, 'Hey, we're going to pre-cut all of this for you, we're going to give you a manual of how to do it,' or to take a more extreme example, 'We're going to pre-assemble all the walls for you, you just have to show up and nail them together,' the question then goes to the framer: 'How much to frame that house?' And they say, 'Oh, I know the answer to that. It's $8,000.' And our answer to that is, 'Wait a minute, it doesn't make any sense. We already cut it all, we nailed it all together already. You just have to show up and put it together.' They say, 'Yeah, but that's what I charge.' That's the resistance to adoption because the framers are unfamiliar or uncomfortable with the idea that they could do more houses and make more dollars in total by taking advantage of the efficiencies that come from some of these offerings to be more of what they are. One way that we get there anyway is the obvious way: you've got to convince the framers to use this new technology. Some of them do. We train them, we help them along the way. You can tell the builders to strong-arm the framers, but it's just slow, and that's the history. One way we've been successful though is we just use it ourselves. We offer install. We'll install the framing for you. We'll charge the $8,000 and say, 'You don't have to worry about it,' or maybe we'll charge $7,800 or $7,500 in order to be able to get the business. That's one way we've been able to leverage the technology, whether it be ready frame depending on the market, or framing, or the whole thing if we're talking about North Florida construction, but we'll sell you the shell. That's where it gets a little bit more interesting and where the increased use of digital makes it even easier for us to make that as an offer.

As usual, Bob, that's a great point. This is a country that is very heterogeneous when it comes to the way we build. It is materially different in terms of approach, even materials used, even who you do business with between California and Texas and Florida and Maryland. The nature of what you're doing is very different. In Texas and Florida, you have a high utilization of roof trusses because of that available labor. In both of those markets, you're generally negotiating with the home builder. In California, you don't talk to the home builder in most cases. You're talking to the framer, and so the framer is your customer directly. In parts of Florida, you don't have any framing on the first floor, you're using block. So the whole world is different in each one of those markets. But you're right, it does become a question of adoption, pace of adoption, the value proposition in each one of those markets is slightly different. But what's true in all of those markets is that there are opportunities to take waste out of the build process. That certainly has value. When you overlay some of these digital tools, for example, to take the waste out, the capture there starts to become meaningful. No question, all of us are worried about affordability. Whether you're a home builder or a supplier, we're all worried about affordability of a home. We see no better way to make homes more affordable than to take the waste out of them, and we think we're an important part of that, both in our value-added products but also with our services.

No question in my mind. If you think about the opportunities created by a three-dimensional digital twin and the ability to build off-site, you start to think through the ultimate consequences of virtual builds and optionality. I'll throw AI into the mix, whether it's a person or a machine. You say, 'Here's my design, give me a version of this that's optimized for cost, or give me a version that's optimized for speed, or give me a version that's optimized for sustainability.' There are options for products that you could potentially put into the mix. There's a prerequisite to us going too far down that road, and that's adoption in the core. You have to have home builders that see this as an advantage, see the benefit, need some momentum around that. But my sense of it is high confidence that that's going to happen, and that is naturally going to lead to more and more doors being opened to have incremental products in there. Whether it's products that we already sell that haven't been added yet, or products that other people sell that we can facilitate the sale, there's tremendous value for the builder with that type of optionality. Big builder, small builder, it's a big deal.

I would tell you the high end is probably 80% to 90%. You're talking just everybody's using it. There are certain examples of markets where historically labor has been a real treat, there have been a lot of skilled trades, and so I imagine it gravitates somewhere closer to the higher end of the range. But that's a huge range, 80% to 10%. It's a huge range.

Okay.

I think the answer is different for each one. I think that it's a continuation of the discussion around available skilled trades. It's a continuation of the conversation we were having earlier about adoption and getting people comfortable with the idea that they can make more money by leveraging technology, and again that alignment factor, keeping everybody on the same page if that's the approach you're taking. I don't have a number on millwork and doors. That's a great question, I've asked it myself, I just don't know the answer. But obviously it's a lower penetration on millwork and doors. We think roof truss is by far the most utilized. Millwork, doors, and windows therefore also bring along the opportunity to sell more product.

Right.

It is a BIM. Our digital product is a building information modeling system. I think it's called 5D BIM technically speaking because it has a budget and a time associated with the three-dimensional model. It is unique in that it is built for the industry from a bottom-up perspective. One of the questions we get is, 'Well, the commercial folks have been doing BIM for years.' They have, but they've been doing it for nuclear power plants and skyscrapers. It's very sophisticated and very heavy. We tried to use this for single-family, it doesn't work. So we came at it from the exact opposite direction. We took a window configurator and a door configurator and enhanced it and went from super light to just heavy enough. We're very confident we've got the right solution, and we're not worried about the big guys coming towards us because they told us they didn't want to. We said, 'We want to partner with you.' They said, 'No, go away.'

I won't talk about '24 in terms of our perspective. If I talk broader about the market, I'd say that the builders that we hear from in the public space are optimistic. The big guys in general have done very well in this window of time because of their ability to buy down rates. No question in our mind, the Hortons and the Lenars of the world have certainly leveraged their mortgage companies and their buy-down skills to be able to take share. I think in general, the sense that the interest rates are going to start to come down has people optimistic. In general, I think what we've seen is some optimism about growth versus prior year. But the one thing I would maybe warn people off of is don't extrapolate Horton and Lennar's headlines to what the market's going to do. They're substantially stronger than everybody else, and some of the custom folks are, I would argue, just flat-out struggling. The other 50% of the market that can't buy down rates, they have to deal with the affordability front and center. Some of that's building smaller homes, some of that's not building as many homes.

I actually don't disagree with you. What I will correct you on one point is I didn't say that is my long-term estimate. I said that is the basis on which I built my model. I think the business is going to be tremendously successful regardless of the price of commodities. We have this wonderful position in the market where we make money when commodity prices are low, unlike the mills, and we make great piles of money when the price of commodities are high because we have product, we have access to product, we have the delivery mechanism that people need. What we decided was the best option was to say, 'Look, there's a long-term historical average that no one can argue with. It's a very reasonable and conservative place to start. Let's do our reporting starting with that.' I don't want there to be any question at any point that we can do as good from a commodity price perspective as we've outlined. From then on, it's upside, it's gravy. I agree with you for modeling purposes, we'll likely get there over time, but we've noticed the same thing you did.

We do, but it's pretty dynamic. What I mean by that is each and every quarter we go through and we look at the analysis of where we are with the stock price versus the forecast, with the historical returns on M&A, and where we think we are in the market. We look at a similar analysis for buybacks. There's always a short-term aspect of ROI that you're trying to optimize, but you can never lose track of that longer run perspective either. We compare and try to allocate resources between them in a way to optimize the best we can between that long and short term. The good news is, based on what we're seeing, based on what we believe about this business, all of them are green. All of them are well in excess of our weighted average cost of capital. I think that positions us well to make a lot of good decisions and make a lot of money for investors regardless. We haven't talked about those publicly and I don't plan to, but we certainly look at all of them and compare.

It was interesting. We'd heard the rumors. We do less than $200 million of sales in roofing in a year, so it doesn't really touch us. We don't really do any landscaping, we don't do any pool. It's interesting. There's a certain logic that I respect that the Depot folks believe they have an opportunity to grow with Pro. Those are pros that are maybe a little closer to their world, smaller scale. Mostly your pros in the roofing business are your installers, your smaller businesses, certainly some larger ones. But I think what it boils down to for us is we still have a unique and differentiated position in terms of how we service, our subject matter expertise, the ability to do estimates, takeoffs, value-add, digital. Nobody else has that. Certainly Home Depot doesn't have that. They don't even have trade credit until recently. They're a very different beast, but a scary beast if they decide to look our way. So we continue to try and extend our lead and ensure that we're still the vendor of choice when we're dealing with home builders and pros.

I'll answer it in two different ways. One is to say everybody's a customer of Home Depot and Lowe's. Every one of our customers buys from Home Depot and Lowe's. They run out of duct tape, they need a new drill, they're going to be in Home Depot and Lowe's most days. Where we're competing with them are in small, low single digits of our business in certain markets around the country where we have a retail focus. We talked about Dixie Line in San Lorenzo and Southern California, Spenards in the Midwest. But the bulk of our R&R business is in an offering and a geographic positioning that they can't compete with. Where the bulk of our R&R is, and where I think you're referring to in terms of how do we stay differentiated from them, that's where you're talking about pros that are focused on the large-scale remodels. In HD parlance, the super complex, not the complex, the super complex. Large-scale remodels or specialty areas. For example, we've got a really great deck business in a couple of urban markets that are these smaller pros. But that's where we're layering in our skill set. We've got pressure-treated lumber, we've got composite decking, we've got the ability to design and configure that deck. We've got the ability to deliver it and install it. It's just a very different type of offering in terms of the way we do it. That's something we need to continue to lean into. How do you take all of those skills that we already have and layer digital and design and configuration on top of it to help builders, large and small, and that pro R&R space be better, look better, be more professional?

Right.

I think the first thing is the consolidation story. We did $3 billion worth of mergers in the history of our market, and then we did another $2 billion worth of M&A on top of that, and we're still active. The consolidation story is real. We're by far the biggest. We've got more than 3,800 sales reps in the space, we have almost 600 locations, we have 78,000 pieces of rolling stock and trucks that we're managing our logistics fleet around the country. We're easily a top 20 fleet in terms of job site delivery capability. We're a top 20 fleet period, but our job site capability is really unmatched. You layer all that together, what did we do with it? We've taken out a lot of cost. We've layered on top of all of that this unmatched product portfolio, the investment in technology, the integrated approach with which we go to market, run our business, and then the digital tools that are unmatched in terms of what the industry needs and what we're capable of providing. That has led to margins that are materially different. You talked about gross margins in the mid-20s when you were having a good year. You were talking about high single digits when you were having a good year back when the businesses were small, when they weren't doing much on the value-add side, when it was a third of the business. Now that it's more than half the business, we're talking about a different company.