TopBuild Corp.

Ladies and gentlemen, thank you for standing by, and welcome to the Top Build Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. At that time, if you have a question, please press the 1 followed by the 4 on your telephone. If at any time during the conference you need to reach an operator, please press the star 0. As a reminder, this conference is being recorded Tuesday, February 26, 2019. I would now like to turn the conference over to Tabitha Zing. Please go ahead, ma'am.

Thank you, and good morning. On the call today are Jerry Bolas, Chief Executive Officer, Robert Buck, President and Chief Operating Officer, and John Peterson, Chief Financial Officer. Please note, we have posted senior management's formal remarks on the investor relations section of our website at topbills.com. As shown on slide two of today's presentation, many of our remarks will include forward-looking statements concerning the company's operations and financial condition. These forward-looking statements include known and unknown risks, including those set forth in this morning's press release, as well as in the company's filings with the SEC. The company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events. In addition, we will also discuss non-GAAP financial measures, which can be reconciled to the most comparable GAAP measures in a table included in today's press release. Please turn to slide three. I will now turn the call over to Jerry Voller.

Welcome, everyone, and thanks for joining us today. We finished 2018 with a strong fourth quarter, completing another outstanding year for Top Build. Our strategy, diversified business model, and execution again delivered on our objective of achieving profitable growth. Before discussing our financial results, I'd like to provide an update on our current view of the US housing industry. On our November call, I talked about consumer affordability issues potentially causing a short-term pause within the context of an otherwise strong environment for new home construction. Since then, the Fed has moderated their view on future interest rate increases Mortgage rates have come down from fourth quarter highs, and the stock market has rebounded from an overall negative sentiment that significantly impacted valuations. In addition, our builder customers, as they always do, are adjusting their strategies to provide homes that customers want and can afford. All of these developments are positive for new residential home construction. As an additional overall positive, the general economy remains strong with solid wage and job growth. While we still believe there could be a short-term pause in the near term, all of the factors I just mentioned appear to preclude an escalation of consumer affordability issues. Looking ahead, as shown on slide four, we continue to believe that supply and demand fundamentals will eventually drive housing starts towards the historical average of 1.4 to 1.5 million per year. Inventory is low, household formations are increasing, and we believe pent-up demand is growing. The next quarter or two will certainly inform the magnitude of any potential 2019 pause, inform the magnitude of any potential 2019 pause. But whatever shape that takes, our diversified business model that includes installation and distribution in both the residential and commercial markets and a core competency around acquisition, selection, and integration offers multiple avenues for growth and gives us the ability to perform well in any environment. Although John will get into further detail regarding our fourth quarter and full year 2018 financial results, let me discuss a few of the overall trends. Turning to slide five, within the context of 90-day lag housing starts, which were up 5.3% for the year, our total 2018 revenue increased 25.1%, with same branch up 8.5% and acquisitions contributing 16.6%. We view this as outstanding top-line performance, driving share in our existing branches and expanding our footprint aggressively through acquisitions. At the gross profit line, fourth quarter 2018 improved 40 basis points over fourth quarter 2017, and total year 2018 was flat at 24.2%. By far the most significant factor was our ability to successfully offset unprecedented material cost increases with higher sales pricing. Given our expansive geographic footprint and customer base, achieving this delicate balance between price and volume has been a monumental effort by our operators across the country. And they've done an outstanding job. It also reflects positively on the quality of our partnerships with both our suppliers and customers. Adjusted operating income and adjusted EBITDA margins expanded, both for the fourth quarter and full year. The incremental EBITDA margin, a key metric for us, was strong in the fourth quarter and finished the total year at 17.9%, 25.1% same branch and 14.3% for acquisitions. Our consistent culture of operational improvement and the leveraging of fixed costs across the company are the key drivers of this excellent result. Beyond that, our core competency around integrating acquisitions has produced excellent returns on the capital we are spending on our number one capital allocation priority. Moving to slide six, looking back on 2018, other significant accomplishments include closing and integrating three acquisitions, including USI, that are expected to generate over $410 million in annual revenue with significant synergies driving margin results, completing a $400 million bond offering at 5.625%, returning $65 million of capital to our shareholders through a share repurchase program, and winning the 2018 Energy Star Partner of the Year for our continued leadership in protecting the environment through superior energy efficiency achievements. Top Build Home Services has been an Energy Star Partner for 16 years by working closely with home builders and consumers to create homes that are more comfortable and energy efficient. As we looked at 2019 on slide seven, we are optimistic that it will be another year of profitable growth for capital. The housing market, even if there is a short-term pause, will eventually regain momentum due to strong supply and demand fundamentals. Our enhanced size and scale facilitate strong supplier partnerships and contributes to the outstanding value proposition we provide our customers. We will continue to drive operational efficiencies, improve sales and labor productivity, and leverage our cost base with higher revenue and further improve margins. Capital allocation remains an important component of our shareholder value creation strategy, with acquisitions being our number one priority. Our pipelines are robust with a primary focus on profitable companies within our two core businesses. As a reminder, We seek well-managed companies with solid customer bases that expand our market share in high-growth regions. Past beyond what is required to fund internal growth and acquisitions will be returned to our shareholders through our newly authorized $200 million share repurchase program. John, let me turn it over to you.

Good morning, everyone. As Jerry noted, we finished with a strong fourth quarter, which closed out a solid 2018 for Topfield. I'll start by discussing our fourth quarter results on slide eight, then provide an overview of full year 2018. In the fourth quarter, consolidated revenue increased 27.6% to $639.5 million, driven by $105.7 million of revenue from companies acquired since January 2018, as well as improved selling prices. On a same-branch basis, revenue increased 6.5% compared to fourth quarter 2017. Gross margin expanded 40 basis points to 24.7% compared to the same period a year ago, demonstrating, once again, our ability to recover material cost increases through selling price increases and operational efficiencies. Adjusted operating profit grew 32.1% to $67.2 million, with a corresponding margin improvement of 40 basis points. Both gross margin and operating margin improvements were driven by higher selling prices, improved labor and sales productivity, and USI synergies, partially offset by higher material costs, higher amortization expenses, and higher share-based compensation costs. Fourth quarter 2018 adjustments totaled approximately $2 million, primarily tied to the integration of USI. Fourth quarter adjusted EBITDA was $82.5 million compared to $57.9 million in 2017, and our EBITDA margin was 12.9%, a 130 basis point improvement from fourth quarter 2017. Our drop down to adjusted EBITDA margin was 17.8% in the fourth quarter, On a same-branch basis, adjusted EBITDA was $65.3 million, and our drop-down to adjusted EBITDA was 22.5%, driven by improved selling prices, USI synergies, strong cost control, and continued leveraging of our platform, partially offset by higher material costs. Incremental EBITDA related to our three acquisitions was 16.3%. Looking at our full year results, total sales increased 25.1% to $2.2384 billion, principally driven by the three acquisitions we completed in 2018, along with volume growth and increased selling prices. On the same branch basis, revenue increased 8.5% to $2.068 billion. USI, which we acquired last May, contributed $266.3 million to our top line. In addition, EBITDA margin from acquisitions was 14.3%, of which USI was the largest contributor. Adjusted gross margin was flat at 24.2%, as there was a delay in recovering first half 2018 material cost increases. The second half of 2018 saw gross margin expansion, offsetting the margin compression we saw in first half. As Jerry pointed out, our operations teams did a great job of successfully navigating three material cost increases during the year. Our adjusted operating margin expanded 80 basis points to 9.8%. Adjusted EBITDA for 2018 grew 43.4%, $283.4 million, and our EBITDA margin improved 150 basis points to 11.9%. Our drop down to adjusted EBITDA margin for 2018 was 17.9% and 25.1% on a same branch basis. Moving to slide nine, adjusted net income for the fourth quarter of 2018 was $42.2 million or $1.20 per diluted share compared to $30.1 million or 84 cents per diluted share in the fourth quarter of 2017. Adjusted net income for full year 2018 was $149.3 million, or $4.19 per diluted share, compared to $101.8 million, or $2.78 per diluted share for full year 2017. Interest expense in 2018 increased from $20.7 million to $28.7 million, primarily related to the funding of the USI acquisition which included the issuance of $400 million in your notes and our borrowing of the $100 million delayed draw term loan. As shown on slide 10, CapEx for full year 2018 was $52.5 million, approximately 2.2% of revenue. During the year, we issued $26.6 million of equipment notes to fund our fleet acquisitions. Working capital as a percent of pro forma trailing 12-month sales was 10.4%, 130 basis points higher than prior year. The biggest driver behind the increase is that USI had a higher mix of installation versus distribution business, and the installation business comes with higher working capital requirements. We've updated our long-term outlook range for year-end working capital from the previous guidance of 10% to the reviving guidance of 10% to 11% of revenue. In 2018, our effective tax rate finished at 25.5%, primarily due to a one-time beneficial adjustment in 5%, primarily due to a one-time beneficial adjustment in 2017 of our deferred tax assets and liabilities to reflect the change in the federal tax rate. Operating cash flow was $167.2 million for the year. On the next slide, you can see we ended 2018 with a net leverage of 2.19 times using pro forma EBITDA well within our comfort zone of two to two and a half times. Total liquidity at year end was $291.6 million, inclusive of the available balance on the revolver of $198.7 million and cash of $100.9 million. Moving to 2019 annual guidance on slide 12, we are projecting total revenue to be between $2,570,000,000 and $2,635,000,000 and adjusted EBITDA could be between $310,000,000 and $330,000,000. This guidance assumes a range of residential new housing starts at between $1.26 million and $1.3 million. It does not include any acquisitions we may make this year. We have changed three of our long-term modeling assumptions, including working capital, which I already mentioned. The other two are a change to our normalized tax rate, which we now project in a range of 26 to 27% instead of a flat 27%, and our estimate of residential revenue top that will generate for every 50,000 increased in residential starts, which has increased from $75 to $80 million. Robert will now discuss operations and segment results.

Thanks, Sean, and good morning. Before discussing True Team and Service Partners financial results, I want to thank our employees for their hard work, dedication, and ongoing push for operational excellence throughout 2018. What a great year and I cannot be proud of our entire Top Build team. While continuing to work safely and provide outstanding service to our customers, we successfully managed the acquisition, financing, and integration of three companies, including USI, which had 38 branches and over $1,000. In addition, our local teams achieved selling price increases, which more than offset an unprecedented three material cost increases over the 12-month period. 2018's strong financial performance clearly demonstrated the effectiveness of our energized, very engaged, and diverse team of 10,000-plus individuals. Looking at True Team's results on slide 13, Fourth quarter sales increased 36.1%, with USI contributing over 74% of that growth. This acquisition continues to perform exceptionally well. On a same-branch basis, True Team sales were up 8.9% in the quarter, driven by a 5.9% increase in selling prices and a 3% volume growth. For the full year, True Team same-branch sales were up 10.1%, with volume driving 5.9% of that growth outpacing lagged housing starts of 5.3%. Shifting to True Team's adjusted operating margin, we saw a 20 basis point decline in fourth quarter to 12.5%. Primary drivers were the absorption of acquisition fixed costs, mainly from USI, higher amortization expenses, and timing adjustments of insurance accruals versus 2017. On a full-year basis, True Team's adjusted operating margin expanded 80 basis points driven by our volume leverage, higher selling prices, and operational efficiencies, partially offset by higher material costs and USI fixed costs, as well as higher amortization expenses. Overall, great operational execution by True Team's leadership and everyone in the field. Our crew team branches also continue to grow their spray foam business, which is benefiting from increased fiberglass costs, new building codes, and consumer education. For the four years, spray foam sales increased almost 39%, 16.5% on a same branch basis. Turning to service partners on slide 14, in the fourth quarter, total sales grew 10.7%, led by selling price increases of 7.9% and acquisitions, notably USI and ADO products, partially offset by a volume decrease of 5.3%. The volume decline was driven by deliberate price-volume decisions and the decision to exit some low-margin business. As a result of these decisions, ServicePartner's fourth quarter adjusted operating margin expanded 80 basis points through a robust 10.1% driven by improved selling prices and strong cost controls. partially offset by higher material costs and the absorption of acquisition fixed costs and deal amortization expenses. For the full year, service partner sales were up 14%, driven by higher selling prices and acquisitions, while volume was flat. Adjusted operating margin was 9.6%, flat versus a year ago, primarily due to the timing of material cost increases and the delayed recovery of selling prices throughout the year. Distribution revenues from spray foam increased 32% in 2018 and 21% on a same-branch basis. I do want to briefly discuss material. Fiberglass remains tight, with manufacturers keeping a firm rein on supply. It's too early to tell the traction of the January price increase, but we do believe if there are additional material cost increases this year, they will be highly dependent on industry demand and housing starts. Turning to USI on slide 15, With the exception of our branch optimization effort, which we expect to finalize by late June, the integration is essentially complete, and as you can tell from our results, USI's performance has been outstanding. Our integration team did a great job, and we are highly confident we will exceed $15 million of cost-saving synergies within two years of close. USI has been a great addition to our company. Our total commercial business grew 28.1% for full year 2018 and 11.8% on a same branch basis, exceeding our long-term target of 10% annual growth. We continue to drive improvements in this business and it remains an important avenue for growth. Our commercial backlog is strong and our bundled services approach is giving us a competitive advantage. In summary, 2018 was a year of solid execution. Our discipline cadence for how we run the business and our focus on improving or shutting down underperforming branches has proven to be a successful strategy. We have built competencies in new products and services as well as acquisition selection and integration. We've also been focused on continuing to build our talented team and developing our bench strength. On slide 16, You can see that this year, an important strategic initiative we are undertaking is a deep dive review of adjacent product offerings that will provide value to our existing customers and enhance our relationships with certain supplier partners. One potential area of expansion, which we mentioned in the past, is glass and windows, a product line we expanded into through the USI acquisition. There are other adjacent businesses we're evaluating as well. However, be assured, We will be very deliberate in our approach, putting scale, talent, and synergies at the top of our criteria list. As mentioned last quarter, I am constantly in the field working directly with our customers and suppliers. Builders seem increasingly optimistic that 2019 will be a good year. We are encouraged by our start to 2019 and are pleased to see our customers moving to build more entry-level homes that families won't and can't afford. Turning to slide 17, even if there is a short pause in housing starts, Top Build's model supports profitable growth from a number of vantage points with a continued focus on driving operational improvements through best-in-class execution, growing our heavy and light commercial businesses, expanding into adjacent product areas, and increasing market share organically and through acquisitions. Our track record over the past few years of expanding adjusted operating and EBITDA margins speaks to our success and our ability to identify and integrate strategic acquisitions is a distinct competitive advantage. We believe 2019 will be another solid year for Top Build and we look forward to once again delivering strong bottom line results for our shareholders. I'll now turn the call back over to Jerry.

Before opening it up to questions, I want to again emphasize that we look forward to 2019 as another year of profitable growth. The external environment is positive. Our strong and diversified business model has produced excellent results, and our team executes well. Operator, we're now ready for questions.

Thank you. Ladies and gentlemen, if you would like to register a question, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the 1 followed by the 3. If using a speakerphone, please lift your handset before answering your request. One moment please for our first question. Our first question comes from the line of Michael Wood from Nomura Incident. Please proceed with your question.

Hi, good morning. This question I wanted to ask about this. In a relatively flattish demand environment for new construction, would that type of an environment benefit relatively large customers like yourself with having more ability to push out price acceptance on insulation? How do you think about your relative positioning?

Hi, Mike. Good morning. This is Robert. As we think about that, I think one thing to keep in mind is just the importance of labor. That's, you know, still top of mind to our builder customers. And so as we think about, you know, things were, you know, flatter slightly up in the year, obviously, we had a bundled solution of material and labor, and labor still very, very valuable and the service that we provide, you know, to our builder customers or to the general contractors and stuff as well. So, you know, if there is price, you know, to be gained or, you know, pricing environment, we feel comfortable with our ability to execute, you know, day to day in the field at a local level. And I think, as we mentioned before, we have a very diligent process as to how we do that.

The other thing I would add to that, Michael, would be that, you know, our diversified model, what I mean by that is, you know, installation, distribution, residential and commercial both. So we do have some diversity across our total model. which in an environment like the one we may be looking at where it's, you know, we're projecting it to be slightly up from 2018, you know, I think the diversity that we have in our model is going to play extremely well.

Great. And thank you for the color on 2019. Is there any guidance or color that you could provide us in terms of first quarter, given the lag, decline, and starts? And I'm just looking in terms of any inefficiencies that might be there on seasonally low demand that you can call out to help us model that cadence.

Yeah, we can't really give you much detail in the way of what's happening with Q1. But what we can say is that we did put guidance out there for 2019. And it is true that over the years, there is a bit of seasonality in our business. Q1 is normally not a stronger quarter. But what I can tell you is that what we're seeing so far in the first quarter is consistent with the guidance that we put out there for the year. So I think that's what we can say. And we feel good about it.

Okay. Thank you.

The next question comes from Phil Ng with Jefferies. Please proceed with your question.

Good morning, everyone. This is Maggie on for Phil. Looking at service partners, can you talk us through that volume decline and how much of that was driven by deliberate pricing or volume decisions on your side versus a softer demand environment in 4Q?

Hi, good morning. This is Robert again. So, yeah, I would say really all of the deliberate decisions on our part, I think the team did a good job of making some good price volume tradeoffs. You know, I actually believe the service that we – So we provided valuable. And then I think we also mentioned there was some lower margin business that we made the conscious decisions to back away from as well. At the same time, I think we feel very confident in what we're doing at the local level with, you know, obviously gaining share with current customers, but the door is always open with other customers and new avenues that we're pursuing as well from a growth perspective. So I would say it was all driven by deliberate decisions that we consciously made.

Got it. That's really helpful. And then you've done a great job on price costs, and it may be too soon to talk about how the January price increase is coming through. But what are your expectations for 2019? And then what kind of impact are you expecting from the recent announcement that one of the manufacturers is shuttering some capacity? Thanks.

So relative to the January price increase that was announced, too early to tell, too early to see if there's traction with that increase as of yet. As you know, the spring selling season just really started a couple weeks ago, early February, if you will. So a little early to tell traction of the January 1 price increase. As I mentioned earlier, I think the traction of future material cost increases will be based on demand and You know, what happens with the housing starts, which you heard Jerry and John's comments on that. And then relative to, yeah, we've seen where there's been some, you know, small lines bought down or some capacity bought down based on some other public announcements that came out. You know, not too concerned about that. I mean, material may be a little tighter in the back half of the year as things improve and as starts improve. But, you know, at the same time, we see other products. I think we constantly mention we see other products like spray foam, that we're using more and more of that's, you know, offsetting some of the capacity issues, if you will, on the fiberglass side. So, you know, not too overly concerned about that, but, you know, we're constantly in communication and talking with the manufacturers.

All right. Thanks, guys.

The next question comes from the line of Ken Zenner with KeyBank. Please proceed with your question.

Good morning, everybody. Morning, Sam. Very good delivery of price and operating leverage. My question is about FY19 and the comment around price, which obviously is the price you would pay to manufacturers, but also the price that you're able to get from the builders. The housing start number that just came out here looks like it was 1247 for the year, FY18. If you hold that annualized number at FY18, it means you're basically going to be having it down, you know, January through February and just kind of on a lag basis. Is it possible to really have – is there a circumstance that you can think of where you really had down volume and up pricing within your guys' long history in this space? Incremental pricing, that is, when volume was falling.

Ken, I think – this is John. I think Robert mentioned it before. Those situations where volume's either flat or down a little bit, where labor obviously comes into play and the availability of labor is critical, would create in some cases an opportunity for some of our branches to drive price. And we've done that in the past, by the way, around the country in certain timeframes throughout the past three or four years. So that really would be the opportunity, I think – you know, when those options present themselves. Again, labor is a very, very critical element of the three-team side of the equation.

The other thing is, Ken, just to add on to that. So, yeah, we just saw that number starts were low. Permits were pretty solid, actually, I think slightly above December. So, you know, that in combination with, you know, as Robert discussed, he has all kinds of conversations with builders. They – They appear to be tweaking their strategies. They're not pessimistic. They're optimistic about what 2019 is going to look like. And as I said earlier, you know, our guidance for 2019 reflects volume being up, you know, low single digits from 2018. And, you know, we think it's going to be a good year. I mean, some things economically, the economy remains strong. Interest rates certainly have changed the picture a bit as we turn the corner into 2019. And so all in all, I mean, we certainly realized that Q4 was a bit of a rough ride, but we think a number of things have changed here as we go into 2019. And, you know, we're optimistic.

We're happy with where we're headed. Yeah. No, I think that's clear from your results. And, you know, on slide 13, you talked about spray foam. And at the Builder Show, we had extensive dialogues with some of those companies. Can you talk, you talked about spray foam increasing 39%, 16%, same branch. Can you just give us, a context again for how much of your business is spray foam today in terms of either value or units or both. Thank you very much.

Yeah, Ken, this is John. So on the residential side of the business, something just around 10% roughly in terms of a unit basis and something just under 20% on a sales dollar basis would be spray foam.

Thank you.

You're welcome.

The following question comes from the line of Matt McCall with the Seaport Global. Please proceed with your question.

Thank you. Good morning, everybody. Good morning. So you walked away from some unprofitable business, and then you've got the USI synergies that are still going to flow through. Can you talk about the impact on those two items on the assumed organic incremental as we move out into 19 or what's the organic incremental that you're assuming in the 19 guide?

Yeah, this is John. We really don't break out and we're not going to break out. Certainly, we've got four months worth of 2019 where we'll still be comping USI versus prior year where we didn't have the comparison, obviously. So, And we're not done from a synergy standpoint. We've done a lot of the work. Most of the work completed on the back office, all the work on the supply chain side. But, you know, we'll go well into the third quarter in terms of branch consolidations taking place. So we'll continue to see those benefits accrue throughout 2019. Those benefits accrue throughout 2019.

Thanks, John. I mean, is it safe to say with those items that the assumed incremental, be it organic or not, is going to be toward the high end of the range? Because I think this year you had a little bit of a – I think you spoke about it, the disconnect, the catch-up period for price versus cost. It was a little bit of a drag in the first half on gross margin. So am I thinking about it the right way, that toward the high end of the range would be the right way to think about it?

If you look at our guidance, basically, you can do the math of taking our 2019 guidance, either low-end, high-end, or make the midpoint. If you take the midpoint on that, you're going to be within our EBITDA pull-through assumptions that we provide on a long-term basis.

Okay. Maybe the way to ask is, are there any negative offsets to those positives that would be incremental to the normal? Yeah.

Again, really on a guidance basis for 2019, the only thing we're really going to provide is the kind of the guardrails around our estimate, which is the starts of $1.2 million to $1.6 million to $1.3 million. You know, we're not going to sit and break down the elements of cost and price and all those types of things. So suffice it to say, I think Jerry said it well, we feel real good about that projection from a guidance standpoint and stand by it at this point.

Okay. That's fair. Maybe if I think about the top line, so you're assuming I think low single digit starts growth. I assume the long-term commercial target of 10% is a good number for 2019. Plus, I think you'll get some carryover price, so kind of not depending on what happens in 19, you'll get some carryover price from 18. Yeah, there's only 4%, I think, assumed growth at the midpoint on the top line, or they're Same kind of question, are there some offsets or am I giving too much credit for any one of those buckets?

Again, Matt, we're not going to attempt to break it down by element here. By the way, we don't use our long-term modeling assumptions necessarily to come up with our annual guidance. Certainly, we baked in commercial assumptions, pricing assumptions, and some volume growth assumptions. Again, we feel pretty good about the growth that we're projecting, and we think it's in line with the estimate we have around residential housing starts.

Okay. Maybe I'll slip one more in. You've talked a lot about labor and labor availability, and we've seen completions kind of lag starts this entire cycle. There hasn't been a period where we've worked into the backlog at all, so I guess the question is, Is there the potential for some of the builders to work down some backlog, and that may help you because you're involved at such late stages of the construction project? Would it help you maybe get through this period of softness or pause a little better than the 90-day lag starts would indicate?

Yeah, this is Mathis Roberts. So sure, I mean, there could be some working into the backlog for sure. That's not uncommon in Q1 that there is some working in the backlog. And if you maybe go back a couple years, I think maybe coming out of 16 into 17, there was some of that for sure that was noted. So that can always be the case, you know, working at that backlog piece.

Yeah, and I think the other thing, this is John, to add to that, keep in mind 20% of our business is commercial. And that commercial backlog, as we talked about in the past, has a much longer tail on it. So the solid business to work on there, obviously.

Okay. Thank you all.

Sure. The following question comes from the line of Trey Morris with ISI. Please proceed with your question.

Thanks, guys. I was wondering if you could talk a little bit more about these adjacent product offerings that you talked about. Are these products that you would think to add to your existing branches or are these somewhat separate businesses that you look to get into initially through acquisitions and then roll into your existing footprint?

Hey, good morning. This is Robert. We talked about glass and windows. We're looking at other businesses. I think the main thing is we have a very deliberate and diligent process that we're going through here. We've definitely learned from some of the past years of how to make these businesses very successful. And I think your question about existing branches, new branches, I'd say both. We never want to distract from our core business. That's something we're very, very focused on. If it takes and it's a robust market that we're into, it could be a separate branch or separate business that... We'd obviously leverage some fixed costs there, but we would never distract from our core business. That's something that we're very, very committed to and do not want to ever distract from our core business. I think we've done a good job of showing that we don't do that. Even acquisitions, that type of thing, we stay very focused on the core business.

Hey, guys. It's Steve Kim, also from Evercore. Just a general question here. You said that We've heard that you've shifted in your trim team business from one of your major suppliers and that their capacity curtailments were actually taken in response to that to drive industry utilization rates for all the other manufacturers into the high 90s. So you have a very sort of a bifurcated situation in terms of the capacity on the supply side. Generally, your strategy has correctly assumed kind of rational behavior from the suppliers and so if someone has extra capacity, you can buy it at a discount given your scale. I was curious, though, if you have a lot of that capacity or virtually all of it in the hands of one supplier, is it possible that your ability to purchase at a discount, to continue to purchase at a discount, might become more dependent upon suppliers actually green-fielding new capacity in the future? And how quickly could that come on if they did?

Yeah, Jerry here. I would say on that one that, you know, one of the things that we do really well, and it's because of our size and scale and the long-term relationships that we've had with our suppliers. I mean, we do business with all four of the major fiberglass manufacturers, and because of our size, we're able to be significant to all four of them individually. And, you know, we work with these folks, Robert and his team, you know, I would say every week we're on the phone with them discussing this and that, and It's always a very fluid situation with all four of them. And, you know, we have our objectives. They have their objectives. We find the middle ground. And that continues. So there's an ebb and flow always relative to what we're doing with any particular supplier. With the one you're talking about, we do a lot of business with Owens Corning. They're the ones that announced that we saw that had the shutdown on the West Coast. We do business residentially with commercial. all across our footprint with those folks. I can't give any more detail than that, but we think that each of these suppliers are their individual businesses. They make their own decisions on capacity, and I'm sure that they'll be looking out into the future. I think, generally speaking, they probably view the housing trajectory longer term the same way we do. Ultimately, I think the capacity will be right-sized as time goes on, and, you know, it's not just about fiberglass. It's about spray foam and other kinds of insulation. Fiberglass is not the only way to insulate a house. So I think all those factors are relevant, and I believe that, you know, our business model affords us the ability to handle it really well, which we'll continue to do.

Great. Thanks very much, guys. Sure.

Ladies and gentlemen, as a reminder to register for a question, press the one followed by the four. The following question comes from the line of Keith Hughes with SunTrust. Please proceed with your question.

A question on spray foam. More great growth in the quarter on the product. The builders are clearly mix shifting down to lower-priced homes, smaller footprints. But particularly on the lower-priced homes, there's probably going to be some pressure on mix and product. So that's my question on spray foam. Do you anticipate that growth to slow down given what the builders are having to do to move units. And if that's the case, does that matter to you, which products they use?

Hi, Keith. This is Robert. So, you know, let me start with your last question. We're pretty agnostic, so we do everything. We do all varieties of installation based on what the need is and, you know, the different solutions we give the customer. And then also maybe feeding into your first question, depending on what's going on with building codes. So, you know, there are codes that are driving this, whether it be smaller homes, larger homes. Obviously, the bigger concentration of spray foam is with the custom builder and the larger regional builder, if you will. So, you know, I think you're going to continue to see it. I think, you know, there's opportunities in certain markets. I could pick on Southern California, where you can decontent out of the homes some relative to the HVAC and other things, which make, you know, spray foam a much, much more attractive product. offering in those types of homes. I think we feel comfortable. The last thing I just mentioned is we're seeing it spec more and more on the commercial side of the business as well. There's adoption, residential and commercial. I think we feel comfortable that it's continuing to move ahead. I would also say the suppliers are doing a great job of some innovation in the product, better yields in the product and stuff as well. It continues to gain efficiency from that perspective as well.

That product tends to move around in price based on the underlying chemicals. Is pricing now, has it come off from some of the highs we saw when crude moved up, or can you give us any kind of feel on where that stands? The highs we saw when crude moved up, or can you give us any kind of feel on where that stands?

There were some minor, I would say, Keith, some minor fluctuations in 2018, but nothing significant from that perspective.

Okay. Thank you.

Sure. The following question comes from the line of Megan McCart with Buckingham Research. Please proceed with the question.

Thanks. Good morning. I just wanted to touch a little bit on capital allocation with your share repurchase announcement. Maybe give us a little bit of an insight into how you're thinking about the share repurchases versus potential M&A and the timing of getting your debt ratios back down into your comfort level.

Peg and Jerry here. Acquisitions continue to be our priority. We feel good about the fact that we've proven our ability to select and integrate those. More than ever, we believe acquisitions is the number one priority. They are very lumpy going forward. We can never really quite scope out exactly when these acquisitions are going to occur and how big they'll be. We always have a number of them on the burner at any given time, but But, you know, when they get to the finish line is always an unknown. So on the buyback side of things, that will be dependent on where we go from an acquisition standpoint. We have the authorization out there that extends out, you know, quite a bit of time. We always want to have the ability, if the acquisitions are not getting to the finish line quick enough and we think that it's a good time to buy our shares back, we want to have the authorization out there. So that's really what that was about. because that's our second priority from a capital allocation standpoint behind acquisitions.

Great, thanks. And then just wanted to circle back a little bit on your conversation around getting into potential new product lines. Maybe a bit of a history lesson, and for those of us that have been around a while, I think you're trying to reassure us that, you know, the past mistakes weren't going to be repeated. But maybe it would be helpful to talk about, you know, when you were a part of MASCO, added a lot of product lines, ended up sort of getting rid of a lot of those. So what were the lessons learned there? What are the things you don't want to do as you move into new product lines again?

Good question. Yeah, I understand all the history, as do Robert and John. And I would say the lessons learned, Megan, at that point in time probably were don't try to do too many things too fast. And we find that at the branch level, the more focused we can keep our operators on the core business, the better we'll execute. And that is one of the primary lessons we learned. And I would say the other thing is as we step into and as we consider some of these adjacent product categories, to Robert's point earlier, we're going to be very diligent about the criteria. And so the criteria is things such as, Is there an adequate level of business to be had? Can we scale it up? Can we scale it up to significance? And the second thing would be, the elements of the business, do they enable us to make money? We want to have adequate margins that are accretive to our business when we're adding something on. And then the third thing is, can we execute it? Is there any synergy with our current business? Do we feel like we have the talent? either in the house or talent that we can acquire that can execute it well. And so I would say if those three boxes can be checked and, you know, and we have the balance sheet to be able to extend ourselves a little bit into some of these categories, we'll be thinking about doing that. But to your point, Megan, we'll be far more careful than we were at one point in time in our history. And we'll be stepping carefully because, you know, we don't want to lose track of the core business that we are very good at. That's something we will not do.

Great. Thanks very much.

Sure.

The final question comes from the line of Justin Spear with Zalman and Associates. Please proceed with your question.

Good morning, guys. Thank you. Just a few questions. One on the intermediate term roadmap. I know you mentioned I think here on the call 75% million to 80 million now for every 50,000 change and starts. Just wondering what goes into that. And then as you unpack that, thinking about that mid-cycle margin view, I think you're originally like a 13.5% mid-cycle at 1.5 million starts. But with USI and some of these other acquisitions in the equation, does that change the calculus on where you think you can take revenues and ultimately operating margins in a 1.5 million scenario in the next few years?

Yeah, so the first question, again, was just to... You mentioned that your product category, for every... Yeah, the 75 to 80... Right, for every 50,000 starts. We did bump it up. So we did the 75 million at the time frame we did the USI acquisition. We had bumped it then. Really, the $80 million reflects primarily the increase in pricing that we've seen in the industry on the residential side of the business. So... What we don't do is make any forward projections behind the current time frame for any price adjustments up or down that would impact that number. So that's what makes it up. The other thing we'd say about our long-term modeling, $80 million, is we assume kind of a constant level of units from a single and multifamily standpoint, so no real change in mix between the two. In terms of where we think that can take us, certainly the long-term modeling we've given will provide – You know, the tools you need to do the projection, it all really depends on where we think we're going to get back to that million four, million five starts. But we have done the modeling, and if you take it out to the 2021 timeframe, 2022 timeframe, we're going to be in that 13% to 14% type of EBITDA margin number as a business in total.

Perfect. But no changes post-USI. That 13% to 14% still looks salient and good. Thank you. That's a good point. The next question I have is just to follow up on available fiberglass insulation capacity at the manufacturer level. Just looking at the capacity there, based on your math, how much capacity do you think is available in the industry under your 2019 starts assumptions?

Hard to tell. I mean, we would say the industry is probably running at, you know, 90% plus, obviously, from a capacity perspective. But, you know, hard to tell, obviously, with the recent announcement from Owens Corning. I know we feel very confident and comfortable with our supply chain, the forecast that we have out there, the conversations with all the manufacturers. I know we feel very comfortable for the year, no doubt about it, and, you know, even looking into 2020. And then probably just reiterate the point, you know, we see some shifting of products and stuff as well. So as we see other products gaining share, I think last call, Q3 call, we talked about cellulose and what's happening there. We talked about spray foam most calls. So, you know, there's other products. I think Jerry said it earlier that you can insulate the house with, and we're seeing builders take advantage of some of those other products.

Okay. And the last question for me in terms of spray foam, what was the revenue? I don't know if it was, 2018 or fourth quarter 18, those metrics you provided in the slides. But what was the fourth quarter growth for both of the businesses for spray foam in the year-to-date growth?

Including acquisitions, the numbers on the two-team side, This is Q4 year-to-date full year was 39% growth on the true team side, again, including acquisitions. Service partners up about 32% on a full year basis.

Okay. And then in terms of the economics there, can you help us understand the economics today of spray foam versus fiberglass versus relative industry and what your assumptions are for 2019 for fiberglass?

Yeah, so in terms of our – I'll answer the last one first. We're not going to give you specific guidance in terms of fiberglass spray foam for 19, if that's the question. But if you're going back to what the economics are, typically on a job, it's double the revenue on a like-for-like job between spray foam and fiberglass. And the margin percentage is roughly even from a percent standpoint. So certainly we drop more bottom line dollars on a spray foam job versus fiberglass.

But in terms of the economics itself, it's still about 2x, even with the fiberglass price increases. The economics have narrowed, but not materially, necessarily.

Well, again, keep in mind about three years ago, three-plus years ago, it was roughly three times. So they certainly have narrowed, but still roughly 2%, two times today.

Perfect. Thank you very much, guys. Appreciate it.

You're welcome.

And we have no further questions at this time, sir. I'll turn the call back to you.

Thanks, everybody, for joining us today, and we look forward to our Q119 calls in the spring.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.