TopBuild Corp.

Greetings 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 star 0. As a reminder, this conference is being recorded Thursday, August 1, 2019. I would now like to turn the conference over to Ms. Tabitha Zane. Please go ahead.

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 topfield.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 conditions. 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 Vollert.

Good morning, everyone, and thanks for joining us today. We're pleased to report another solid quarter, again demonstrating the strength of our uniquely diversified business model and our focus on profitable growth. Before reviewing our second quarter results, I want to update you regarding our view of the U.S. housing industry. On our last call, With mortgage rates moving lower and builders positively reacting to the demand for more affordable housing, we expressed optimism that housing starts would begin climbing higher as the year progressed. Our outlook at that time was further reinforced by a more favorable trend for permits, positive conversations with builders, and a healthy economy driving solid wage and job growth. At this point in time, starts have not accelerated to the degree that we and many others had been anticipating. However, for all the aforementioned reasons, we do expect starts to strengthen further as we move through the year. Long term, we remain bullish on residential new construction. The fundamentals, such as household formations and limited housing supply, point towards continued growth in new home construction activity. Although the slope of growth may be unpredictable and could be choppy in the near term, We are confident starts will improve and continue towards the 50-year historical average of $1.4 million to $1.5 million per year. Moving to Topfield's financial results on slide four, we again reported an excellent quarter as we continue to execute well on our strategy, which includes outfacing lagged housing starts through market share gains and strong operational performance, growing markets here in the commercial space, and converting our top line growth to the bottom line through a focus on improving operational efficiency and leveraging our existing branch footprint and back office operations. In the second quarter, total sales were up 8.9% compared to lagged housing starts that were down 8%. Our commercial business again performed extremely well, and we saw solid residential new construction activity at True Team. While John will follow with more specifics, I want to emphasize that we are particularly pleased with the expansion of our adjusted operating and EBITDA margins of 210 basis points and 260 basis points, respectively. That drove adjusted net income to $1.43 per share, an increase of almost 40%. Our internal focus on share gains and operational efficiency continues to pay off. Turning to capital allocation on slide five, in mid-July, we completed the acquisition of Viking Insulation. This is a well-established, well-managed, and profitable company based in Burbank, California that focuses on fiberglass installation for residential and light commercial projects. For the trailing 12 months ended March 31, 2019, Viking generated approximately $9 million of revenue. Our cost-saving synergies will add to the financial performance of this excellent addition to our national footprint. Looking forward, our seasoned M&A team continues to work a robust pipeline of prospects, primarily core insulation companies, and we expect to close on a number of these opportunities this year. In addition to acquisitions, our capital allocation strategy includes share repurchases, and in the second quarter, This included almost 197,000 shares and an average per share price of $75.57. Before turning the call over to John, I want to emphasize that our national scale gives us a significant competitive advantage both from a material and a labor standpoint. Just as important, our diversified business model with both installation and distribution into both the residential and commercial markets gives us the ability to perform well in any environment. Our year-to-date results clearly demonstrate the value of this business model. John?

Good morning, everyone. As Jerry noted, we continue to generate strong financial results. Starting on slide six, in the second quarter, consolidated revenue increased 8.9%, to $660.1 million, primarily driven by increased selling prices at both true team and service partners, and one additional month of acquisition revenue from USI. Revenue for the first half of 2019 rose 16.6% to $1,279,000,000, including $124.9 million of revenue from companies acquired since January 2018. Gross margin increased 260 basis points in the second quarter to 26.5%, and for the first half of 2019, expanded 250 basis points to 25.8%. Adjusted operating profit in the second quarter grew 32.2% to $76.4 million, with a corresponding margin improvement of 210 basis points. For the first six months, adjusted operating profit increased 41.2% to $135.5 million, with a corresponding margin improvement of 190 basis points. Both gross margin and operating margin improvements were driven by higher selling prices, higher growth of commercial sales, operational efficiencies and synergies from USI, partially offset by higher material costs. Adjusted EBITDA for the second quarter was $94 million compared to $70.6 million in 2018. A 33.2% increase and our adjusted EBITDA margin improved 260 basis points to 14.2%. On a same branch basis, adjusted EBITDA was $87.7 million, a 24.3% increase, and our same branch EBITDA margin was 14%. In the second quarter, our drop down to adjusted EBITDA margin was 43.3% in total. For the first six months of 2019, adjusted EBITDA grew 44.6% to $168.6 million, and adjusted EBITDA margin was 13.2%, a 260 basis point improvement over first half 2018. Our drop-down to adjusted EBITDA margin in the first half was 28.6% in total. Second quarter SG&A as a percent of revenue was 15% compared to 16.7% in the second quarter of 2018 and 16% last quarter. The year-over-year decrease was the result of lower acquisition and closure costs related to USI. On slide 7, you can see adjusted income for the second quarter was $49.5 million, or $1.43 per diluted share, compared to $36.9 million, or $1.03 per diluted share. Second quarter and first six-month 2019 adjustments were $393,000 and $2.9 million, respectively, primarily tied to the acquisition and integration of USI. Our effective tax rate was 22.2% for the second quarter due to some discrete items captured in the quarter. For long-term planning purposes, we still guide to a normalized tax rate of approximately 26.5%, which is reflected in our adjusted EPS guidance of $1.43 per diluted share as compared to our reported EPS of $1.51 per diluted share. For the six months of 2019, adjusted income was $86.1 million or $2.49 per diluted share compared to $63.1 million or $1.76 per diluted share. Interest expense in the second quarter 2019 increased from $7.3 to $9.6 million versus prior year, and for the first half, increased from $9.6 to $19.2 million, primarily related to the funding of the USI acquisition in the second quarter last year. Moving to slide eight, capex for the first six months of the year was $22 million, 1.7% of sales, slightly below our targeted long-term range of 2% to 2.5%. Working capital as a percent of sales for the trailing 12 months was 11.9% versus 11.1% a year ago. This increase was due to a number of factors, including the higher mix of installation business from a year ago, strong growth in heavy commercial, which has longer receivable terms, and the impact of selling price increases. As shown on slide 9, we ended the second quarter with net leverage of 1.8 times, using trailing 12 months adjusted EBITDA, which is slightly below our targeted range of 2 to 2.5 times. Total liquidity at June 30th, 2019 was $328.9 million, including cash of $141.8 million and accessible revolver of $187.1 million. Operating cash flow was $96.3 million for the six months into June 30th. Moving to annual guidance on slide 10, we lowered our outlook for housing starts for 2019 to a range of 1.23 to 1.27 million. Our previous outlook was 1.26 to 1.3 million starts. While this reduction is in line with weaker-than-anticipated starts through the first half of 2019, we expect to see some moderate growth in the second half of the year. As Jerry noted, we remain bullish regarding the long-term health of the residential and commercial markets we serve. Accordingly, we've lowered the high end of our outlook for the total revenue by $30 million to $2,640,000,000, with the low end remaining the same at $2,610,000,000. At the same time, based upon our strong first half performance, we've increased our adjusted EBITDA outlook, raising the low end of our previous guidance by $15 million to $345 million, and the high end by $5 million to $355 million. Robert will now discuss operations.

Thanks, John. Echo Jerry and John's remarks. Topfield is performing very well. Our quarterly and six-month results demonstrate our success in driving profitable growth by focusing on market share gains and operational excellence. Starting with True Team on slide 11, second quarter sales increased 12.5%, driven by selling price increases and one additional month of acquisition revenue from USI. We handily beat lagged housing starts, which as Jerry mentioned, were down 8%. True Team's adjusted operating margin improved 260 basis points from a year ago to 14.2%. This was driven by great operational efficiencies, USI synergies, residential and commercial sales growth, and increased selling prices to offset material cost increases. As shown on slide 12, Service partner sales were up 3.8%, driven by a 5.1% increase in selling prices and one month of acquisition revenue from USI, partially offset by volume decline of 2.6%, primarily related to the exodus from low-margin business late last year. Adjusted operating margin was 9.9%, up 20 basis points from second quarter 2018. On the residential new construction side, our crews remain busy. While we recognize a portion of our second quarter growth is attributable to builders playing catch up from the backlog, we also believe we are growing market share. Turning to slide 13, for the fourth consecutive quarter, we posted extremely strong growth in our commercial business. In the second quarter, it was up 22.1% on a same branch basis. Here today, commercial has contributed 22.6% of Top Build's revenue. As we have consistently mentioned, this is a great business for Top Build and we expect continued strong growth. The majority of our installation branches do like commercial work and we have 18 branches that just focus on heavy commercial jobs. Most of our distribution branches sell and distribute commercial products as well. While we're currently working on many large projects across the country, the more notable ones include LaGuardia Airport, the Comcast building in Philadelphia, the Raiders Stadium in Las Vegas, and the World Trade Center development. Looking ahead, our backlog remains robust and we're bidding projects low into 2020 and 2021. We have enhanced our leadership team in this area And with only 9% to 10% share of this $5 billion plus market, we have plenty of room to grow. As noted on slide 14, we are seeing excess fiberglass capacity in the market that has found its way into the distribution channel and competition has heated up. We continue to work on a positive mix of business to support our distribution margins. We are pleased with both Knopf and Johns Manville's announcements that they will be bringing on new loose fill capacity in the next 18 to 24 months. This speaks to their long-term confidence in the health of the U.S. housing market, and we agree with their optimism. As starts continue their march towards the historical annual average of 1.4 to 1.5 million, we wouldn't be surprised to see additional capacity investments. As mentioned by both Jerry and John, we do expect housing starts to pick up speed as we move through the remainder of the year. In our conversations with builders, they are optimistic 2019 will end up being a solid year for the housing industry. We believe weather may have hampered this acceleration thus far in 2019, but job growth is strong, interest rates are low, and lack of inventory remains an issue. Looking at slide 15, We do believe our financial results demonstrate the strength of our uniquely diversified business model consisting of a nationwide footprint that gives us scale and efficiency, residential construction business balanced with an accretive and growing commercial business, two ways to reach a fragmented industry through installation and distribution, as well as an expertise in all installation related solutions. In addition to our model, Our team manages the business with a constant mindset of driving improvements and achieving operational excellence. We still see opportunities operationally to continue our track record of producing improved financial results. We have the most talented team of operators in the field and a dedicated and experienced group at our branch support center. Our entire team remains focused on delivering strong results and creating shareholder value in every operating environment. We are driving improvements throughout the business and executing extremely well at all levels. And this focus on execution will continue. As always, I thank our entire Top Build team for their hard work, energy, and unyielding focus on delivering continued great customer service and strong bottom line results while operating safely every day. I'll now turn the call back over to Jerry for closing remarks.

Before opening the call up for questions, I want to note that June 30th marked the end of our fourth year as an independent public company. In just 48 months, we have significantly transformed Top Build, successfully executing on a strategy of profitable growth in all areas of our business. Since the second quarter of 2015, our revenue has increased almost 64%, and our adjusted EBITDA margin has improved 840 basis points. Our commercial business has grown from approximately 16% of total revenue to over 22% today. We estimate we touch over 40% of all residential and new home starts versus 30% four years ago. Our capital allocation plan has resulted in 11 acquisitions that are contributing almost $510 million of annual revenue and the repurchase of $246 million of our common stock and an average per share price of $54.10. Operator, we're now ready for questions.

Thank you. 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. The first question comes from the line of Michael Wood. Please go ahead.

Hi, good morning, and great job on the continued marketing.

Thank you, Mike.

First question I wanted to ask about that, your comment about the excess fiberglass capacity has found its way into the distribution channel. Can you just give some information in terms of what that means, the top build, in terms of did you acquire that at favorable prices and, you know, maybe if insulation prices are declining or stable?

Yeah, good morning, Mike. This is Robert. So, yeah, I think we've seen, you know, if you take compared to last year whenever material was tight and some allocation of loose-fill material, You take, you know, the change in that and, you know, relative to housing going into 2019, definitely excess capacity and excess material that's been more prevalent, I'd say, in the distribution channel. You created some competitive situations there. As we've always said, we're constantly in discussions with the manufacturers, and we buy from all four, and that's just a constant business practice from our part. You know, we're focusing on our balanced mix of the business on the distribution side to continue our strong margin performance. But, you know, it's heated up some competitive nature there. But as Jerry said, and as we continue to say, we believe we make good decisions on, you know, profitable volume and price tradeoffs and stuff. So we're confident in that. And we think that, you know, as the back half heats up and the back half volume increases and stuff, that'll bring some stability as well.

Okay. Are you able to quantify the price cost in 2Q maybe split out by True Team service partners?

This is John. Mike, we have the price broken out, but as you know, we don't break out material costs specifically. So on the price side, True Team was up 4.3% on price versus prior year and service partners 5.1. Both of those You know, if you looked at the first quarter price gains, we're down a little bit, but that's because, of course, we were chasing price last year, so the comps got a little bit tougher throughout the year.

Michael, Jerry here. The one thing I would add to that would be in Q2, we're clearly back to price-cost neutrality. In Q2 a year ago, we were not, if you remember back then. So when you look at this quarter versus the same quarter a year ago, there's a stronger performance there. And as Robert said very well, The environment right now for material looks quite a bit different than it did a year ago, which could hardly not be the case since a year ago was highly unusual given the rapid, you know, the machine gun fire cost increases. So it looks a little different today. A couple suppliers abroad, you know, outside capacity that's going to help. And, you know, that will match up, we think, with improving housing starts that are going to happen here. So, you know, it's a really important piece of our model that we partner with our suppliers constantly, Robert and his team constantly. You did a great job of that.

Great. Just finally, are you able to talk about the efficiencies that you talked about? Is this part of normal blocking, tackling, or maybe a rollout or benefits of a bigger productivity initiative? Thank you.

Mike, I think you kind of went out a little bit there, but I think what you asked was, are the operational efficiencies kind of consistent where we've been? And the answer is yes. You know, I think over the past three-plus years, we've talked a lot about that. We've talked a lot about how We manage our branches. Each one has an individual income statement. Each one gets monitored and reviewed every month in significant detail, not just profitability, but looking by product line, by customer, sales rep performance, et cetera. So focusing on that bottom 25% quartile, which is the ongoing way that we really drive and really allocate our resources to the ones that get the biggest bang for the buck. And that you saw again in the second quarter of the first half, and we think You know, we think that doesn't lose any steam as we continue through the end of this year and beyond on the recovery of starts.

The next question comes from the line of Trey Moorish from Evercore. Please go ahead.

Hey, thanks, guys, and fantastic quarter. Thank you, Trey. So I wanted to start on the guide. It really looks like your second-half guide for EBITDA was unchanged, and so while pricing... which we think as having a better fall through to the bottom line was stronger in the quarter and volumes were weaker. And since pricing tends to be a bit stickier and have a greater impact, we would have thought that given the strong price in 2Q, your back half outlook would have been upgraded, especially as we've heard that volumes for insulation contractors and their backlogs seem rather strong at this point in the year. So could you kind of describe the levers here? of what's driving the back half outlook in EBITDA to be kind of unchanged?

Hi, Trey. This is John. Just for clarity, we did increase the lower end of our guidance by $15 million and the higher end by $5 million on EBITDA. Okay? Yes. So that was increased. If you do the math, actually, you take the midpoint of our revenue guidance and the midpoint of our EBITDA guidance, you really back into about a 25% pull-through on incremental on sales growth, incremental EBITDA, which is kind of right in the middle of our long-term guidance. So certainly we expect a strong quarter, and we're forecasting a strong quarter using the midpoint. The reasons it's not quite as robust as the first half of the year, there's a few things I would call out. I'd start with the fact that that sales price and input cost relationship The second half of the year, as you know, last year, we did a good job of driving price in response to significant first half fiberglass cost increases. So the comp on that selling price input cost becomes a little bit more, I'll say, difficult the second half of the year. Commercial, which drove a big part of our growth the first half with nice accretive margins and significant top line growth, the comps on the revenue get a little more challenging the second half where we had a really strong second half 18. So that comp becomes a little more difficult. And then finally, synergies from USI, which if you think about second quarter 2019, we were comping on two months a year ago where we didn't drive significant synergies the first two months of acquisition. The back half we started to get those synergies. So those comps become a little more difficult too. But again, our back half pull through on our guidance taking the midpoint at 25% roughly, we think is relatively strong.

Okay, thanks for that. And going back to something you said in your prepared remarks, you mentioned that you wouldn't be surprised to see additional capacity investments from the manufacturers. Could you elaborate a bit on that statement? And how do you think about the potential for another manufacturer to announce that they were building new capacity at some point this cycle?

Yeah, good morning. It's Robert. So, you know, I think they're always looking at opportunities and their capacity situation. You know, they've changed technologies and stuff as well. You know, they see that as an opportunity for efficiencies, for new capacity on their side. I think that, you know, obviously we're talking to the manufacturers all the time. And as we said earlier, we share their optimism of, you know, the back half of the year and the optimism for housing for the for the future and they do as well. They also like what they see on the commercial side of business, so they see growth in both sides of the business as well. That constant look of that and the opportunity relative to what we'll see, it's hard for us to say. I think that looking forward, there's plenty of opportunities with all four manufacturers as they look at their footprint. As I say, we talk to their upper management on a continuous basis. as well. So they're optimistic. They're looking at their footprint, their opportunities, residential and commercial insulation products. So we say that we think we could see additional investment because, again, I think they share our optimism and they have the opportunity here as well.

Yeah, Trey, I would say that that's a, as Robert said, that's a pretty strong endorsement, I think, of how they view housing mid to longer term. I mean, these, as you know, these are expensive investments that these folks make. And they only do it if they view a payback coming in the future year. So the fact that some of them are now doing that, and to Robert's point, we don't know what's going to happen in the future with further capacity increases, but I think it's a very, very good sign that a lot of people are on the same page here relative to the future of housing, being very optimistic about it.

All right. Thanks very much, and good luck. Thanks, Craig.

The next question comes from the line of Ken Zinner from KeyBank. Please go ahead.

Good morning, everybody. Okay. Good morning.

So, just, obviously, you took a lot of share. Could you kind of walk us through, you know, why you think that's happening here, given your price-cost neutrality? It doesn't seem like you're, right, giving away the, you know, your product.

Yeah. Good morning, Ken. This is Robert. Yeah, I think the first thing that I would probably point to is, you know, we feel like we did a great job on share. If we look at the commercial growth in the business, you know, we're absolutely taking share there and our teams across the country, both heavy and light commercial are very focused on that business. And we've seen, you know, some really great momentum from that perspective. As we look at our, you know, on the residential side of business, all those starts being down, you know, we showed nice performance on the residential side. Some of that was our backlog carrying through. As well in the quarter, but, you know, we feel like in some areas on the residential side, we're doing a nice job of providing great service in a labor tight environment. That's allowing us to pick up share without having to jeopardize from a price perspective. So we feel comfortable share perspective. Great job on commercial and a really solid job by the team in the field on the residential side as well.

Okay, and now, Jerry, I just with comments from obviously OC about. pricing and market share and all that stuff. I mean, you know, only time will tell what's happening. But could you please give us some context? You know, Jerry, you said the back half will bring stability. I think you were referring to price. Could you just kind of walk us through? I mean, because you just did take down, you know, start guidance about 2%. Nothing dramatic, and I don't think there's a big downturn coming, but You know, what if we don't get stability? What's going to happen? I mean, why would the price declines, you know, abate? And when does that price falling input cost, when does that kind of impact your operating leverage too? So to the extent you, you know, you got the pricing through, it's helped your incrementals. It seems as though volumes are down, you know, the industry and pricing is down. It seems like that would have an impact. I'm just, thinking about 05, 06, 07. I mean, it wasn't a great time. You guys have changed your fixed costs, but why wouldn't that be negative if your optimism for second half doesn't come through? Thank you.

Yeah, Ken, I'll say a couple of things to unpack there. So the first thing would be on the housing start revised projection. I mean, we are, in fact, projecting a healthy environment in the second half. I mean, the implied second half housing starts is actually 4% higher than a year ago, second half. And sequentially, it's actually an improvement as well. So the first thing I would say is we actually are projecting a better housing start environment coming up here. And we think that's going to continue into 2020 and beyond. As it relates to the whole material situation, it's certainly going to be different than it was a year ago when we had these rapid fire increases. I do think You know, I can't speak for OC, what they're going to do, how they're now looking at it. The environment is going to be different in 2019. I don't see it as anything highly unusual. It's different than it was a year ago, but last year was the unusual year, not this year. So I think this year is going to be a lot easier for us to manage. And, you know, we are going to do the job that we always do. You know, we do business with all the manufacturers, including Owens Corning. And we will work towards maintaining our price cost neutrality. That's what we think is the sweet spot. And I say that because that enables us to strike that balance between price and volume at our branch level. So that's really important. And then the last thing I would say about our performance in general is, irrespective of what happens with starts, but having said that, we're optimistic, as you know, but the things that we can control such as our relationships with our suppliers, such as the operational performance of our branches, such as our M&A process and our ability to integrate them well. I mean, those are all the things that we spent a lot of time working on. And that's as much as anything else is the engine that's been driving our performance. And that's why we're so optimistic about the future, is that no matter what the environment is, You know, we think, and we think this is a good year to demonstrate that fact, that we're able to, and what so far has been a relatively flat start environment, some really good performance because we're concentrating on those things that we can control. And, again, having said all that, I know I've said a mouthful here, but we see the material price environment this year is historically being kind of a normal situation that we're really good at navigating.

Thank you very much.

Sure.

Sure.

The next question comes from the line of Keith Hughes from SunTrust.

Please go ahead, sir. Thank you. The commercial growth is outstanding. I know you talked about it picked up, I guess, in the second half of the year. What kind of comps are you going to be facing in commercial the next couple quarters?

Yeah, Ken, this is John. I think last year we had about a 17% growth. in the third quarter, and I think it was a little over 21% in the fourth quarter. So compare that to the first half of the year where we were looking at kind of mid-single-digit type of performance. So that's why we refer to the fact that the comps on the commercial side get a little more difficult, the back half, where last year we had some nice momentum exiting the year. And the first quarter, just for reference, what was the first? Again, mid-single-digits, I recall, something like that, low to mid-single-digits, I think, in terms of the growth. Okay.

Okay. And these are all, are these just share wins? There's no, is there any acquisition volume in these numbers?

No, these are all share wins. And, you know, Robert kind of rattled off four significant projects. Behind that four, there's probably another 24 that we could talk about. So we have absolutely done a good job on both in light, but especially in heavy commercial of driving some nice growth and nice share gains. Okay. Thank you. You're welcome.

As a reminder, to queue up for a question, please press the one followed by the four. The next question comes from the line of filming from Jefferies. Please go ahead.

Hey, guys. Solid quarter, particularly on the volume side for True Team, given how weak housing starts have been. Can you provide a little more color? What's driving that? And as you kind of work through some of the backlogs from last year, How do you think about demand in the back end? Is there any risk that volumes actually dip to the negative territory?

Yeah, Phil, this is John. You know, on the volume side, I think we called out the biggest gain from a line of business standpoint, so certainly commercial volumes up significantly or substantially. Did a great job on the residential side, however, you know, in spite of the fact that light housing starts down 8%, and I think we talked about it in the prepared collection, probably in Parts around the country picked up some residential share gains in the business. So that was favorable. And I think, again, just great execution by the teams in the field, both on the residential and commercial side. In terms of the back half, again, I think Jerry talked about it. We saw sequentially first to second quarter residential new construction picking up a little bit of steam. And our expectation is, again, sequentially will probably be about at a midpoint of our guidance, about a 2% improvement, the back half versus the first. And if you take year-over-year comps, about a 4% improvement. So we do expect a good, strong second half of the year. I think you've heard most of the builders echo the same thing in their calls. So that would be our view.

Got it. And then on that share gain front, any color on, you know, What's driving that? Is it just a function of your scale and your service level? And given you're seeing a more muted raw material environment, does that kind of present more opportunities for you to pick up share as well?

I would definitely absolutely start with service. I mean, labor is still at a premium and still top of mind for the builders. So we do a great job of moving crews, equipment, material around to really provide great service for our customers. I think that's absolutely, you know, helped us win share as well on the residential side. But then also on the commercial side, you know, we're taking, you know, really great steps there from a leadership perspective in different areas on the commercial side and taking great share there. Relative to material, you know, I'd say the other thing is one thing that we talk about is that we're a, you know, we're the expert in any type of insulation solution. So as building codes change, as people become more receptive to other types of materials, They look to us first for that. So we've taken share in, you know, other materials outside of just fiberglass, and I think that's part of, you know, that package solution we talk about on commercial. I think that's one reason that we're winning big on the commercial side of the business as well.

Got it. And from an M&A standpoint, good to see you guys get involved again. I think you mentioned the focus will be your core insulation business. How are you thinking about the pipeline you're – comfort in stepping up M&A at this point in the cycle? And then is commercial an opportunity as well, just because it seems like you're making good progress there in winning new business? Thanks.

Yeah, Phil, the M&A pipeline's in good shape. As you know, we did take a bit of a pause post-USI. We're very comfortable with how that all stands at this point. So So without a doubt, we expect M&A to be the number one capital allocation priority as the quarters kick off here. It's always lumpy and it always will be. Yes, we are looking at commercial, without a doubt, as well as residential. Because the commercial space is particularly, it's very attractive as a growth vehicle sitting next to our residential performance because our share there is much, much lower. than it is in residential. So the headroom that we have in commercial is very, very significant. And so, yeah, so residential and commercial acquisitions, we believe we have a process and an engine that performs exceptionally well. When we look back at the acquisitions that we've done to date, in total, the performance is really, really good. So those are the reasons why we think that is the number one capital allocation priority still, and we expect to be very active.

And then, Jerry, from a sizing standpoint on some of these M&A, are there going to be more bolt-ons like Viking both on the commercial and resi side in terms of the pipeline you see out there? Thanks.

Probably. Probably. I mean, there aren't any other USIs out there just given the size of them. You know, there are some fairly large things that we're looking at. But, you know, some of the smaller acquisitions that we bolt on are, you know, generate extremely good financial return for us. So we will be on both sides of that spectrum from a size standpoint.

All right, thanks a lot.

Sure. The following question comes from Megan McGrath from Buckingham Resources. Please go ahead.

Good morning. Thanks for taking my question. I wanted to follow up a little bit on the commercial business. We've talked a lot about this price-cost dynamic on this call, and I think we mostly think about that in resi, but Is there a different price-cost dynamic in commercial? Are you less focused on price as you try to gain share in that market, or are they pretty similar, those dynamics?

Hey, Megan, this is John. Really not a dramatic difference. I think we have seen inflationary cost pressure on the commercial side as we have on the residential side. And if you think about commercial, roughly half of it is light commercial. And light commercial, as we talked about before, you know, uses the same type of products typically that you would see in single-family residential. So we've had to respond to some significant inflationary costs with pricing on the commercial side of the business, too.

Okay, thanks. And then a follow-up on M&A. You made sure to say in your remarks, I think, that you're mostly focused on insulation and And you haven't talked much about your conversations previously about potentially getting into new product lines. So wondering if you could update us on that process.

We are still looking, Megan, at adjacent product categories. I think the one we talked about last time was Glass and Windows, a pretty significant business that we brought into Top Build with USI. We are still looking. That's still performing very well for us. That's one example of a fairly significant potential adjacent product category that we're looking at. So, you know, the priorities remain the same. And what I mean by that is our core business still offers a ton of growth for us. And we're really good at executing on that. And that's why that continues to be so attractive from an M&A. But having said that, you know, we're going to be very disciplined about continuing to look at adjacent product categories. And, you know, discipline is the key word in that sentence. And so, yeah, it's still on our radar. We're going to continue to look at it. And I think as time goes on here, you'll probably see us moving into some pretty close adjacencies, but they're going to be ones that we're highly confident that we can perform really well.

Great. Thanks.

Sure. The next question comes from Matt McCall from Seaport Global. Please go ahead. Thank you. Good morning, everybody.

Hi, Matt. Morning. uh good morning um so a lot of questions i think around lag starts and i just want to clarify i mean the way the way we've always kind of looked at it is is maybe focusing more on the completions data i think completions in q2 are up six percent so i guess the first part of the question is is you have any problem with with with looking at it that way and then secondly um robert i think you talked about you know working through backlog builders working through backlog What can you tell us about the state of that backlog today? I guess how much longer can we benefit or can that backlog help in the absence of a starch recovery?

Hey, Matt. So it's Robert. I'll take the last part of that question first, talking about backlog. So, you know, I think two or three things I would mention is that, one, multifamily. So, you know, as we saw, the lag on multifamily extends. Coming out of 18 into 19, that definitely drove some of the – some of the lag and some of the volume that we talked about in Q2. And the second thing I would just say is, you know, not inordinately have impacted us in any type of negative way. You saw our volumes, but, you know, weather. So weather probably pushed some, as we talked about, start slower to accelerate. Part of that, we believe, is probably because of the weather that hit first quarter and even into second quarter also. So we think that's what generated or, you know, drove the backlog piece of it. And there was a multifamily aspect to it beyond the weather.

Okay. Maybe, John, I understand some of the items impacting the second half incremental margin outlook, but I guess the question I have, wouldn't that be reflected in the year-ago comp? I mean, if pricing was better, price-cost was better last year. It seems like the year-ago organic incremental comp gets easier, and I'm just trying to understand why that wouldn't reflect some of the items you talked about and why we would see such a step-down sequentially. Maybe it's not 75% organic incremental, but why we would move all the way back to the kind of targeted range when we were at the low end of the range or slightly below in the second half of last year.

Right. So, Matt, you're talking about the second half versus first half in terms of the incremental? Okay.

I think I had several parts to what I just said, but yes.

Why aren't we going to have a, I think in average, we were the first half somewhere in the 45-50% range, first and second quarter. Again, there's really three major reasons for that. And again, 25% is something we consider to be relatively strong, which is again where the math gets you in the back half of the year. But again, the three areas would be that commercial growth will be not as significant, and that does carry very accretive margins for us. So that comp becomes much more difficult. The biggest area, I think, by far, though, was, again, last year, as you recall, the first half of the year, we had GP compression chasing those fiberglass cost increases, first and second quarter, low double digit. Had great success the back half of the year, so now we're comping to that. And, again, the comp on that becomes more difficult. And then the other piece that I think is significant also is synergies have been a great part of the story of the USI acquisition. And we got really good momentum the back half of last year, almost little if nothing in the first quarter we owned USI, those first two months of second quarter last year, I should say the May-June timeframe last year. So that's going to become a much more difficult comp. But, again, you know, I want to emphasize we feel pretty good about, you know, a mid-20s type of pool throw and incremental revenue in the back half of the year that we projected.

Yeah, I agree. It's a good number. I just wanted to clarify some of the puts and takes. So I guess the last put or take I have a question about is the price-cost comment. I think you said you're neutral in the quarter. Is neutral the assumption that you have in your back half outlook?

Yeah, we don't break down our guidance in terms of specifics. Having said that, I think what Robert's talked about and Jerry is, and based on even our starts profile, we don't expect significantly tight product in the back half of the year. So inflationary pressures I don't think are going to be as significant. So I think from a product pricing standpoint or a selling price standpoint, Again, I don't think there is going to be as much expansion of selling price. I think you'll see at equilibrium, whatever term you want to use, the back half of the year versus what we saw a year ago, certainly, especially the first half of the year. Okay.

Thank you, John.

You got it.

Our next question comes from Justin Spear from Zellman Associates. Please go ahead.

Good morning, guys. Thank you. I wanted to just unpack that margin just a little bit more. I know I don't want to beat a dead horse, but just looking at typical seasonality, you would expect, based on history, that you could potentially see – I think that's what folks are wrestling with. Typical seasonality would suggest margins would be going higher than where they are casting right now in the second quarter. And so we're just trying to figure out what maybe – you're trying to message either conservatism or if there's something else one time in the front half, and maybe it's that commercial business, I guess that's where I'm leading my questions going, is how much mixed tailwind or lift to margins did you get from commercial being so strong in the first half? And maybe, I guess, if you were to think about the back half, is that maybe explaining a large chunk of the sequential step down in Platinum Guidance?

Now, Justin, the thing I would say, we're certainly not messaging anything negative. I mean, we are feeling like we're on all cylinders in terms of ongoing performance here. I would tell you that Q2, you know, for all the reasons we talked about, you know, the stars did align nicely in terms of our overall margin performance, without a doubt. You know, commercial had a big quarter. Our margins on commercial are actually slightly better than they are on residential. So when our mix moves to commercial, that's a positive. And then, as we've talked about, the price-cost comparison from Q2 2019 to Q2 2018 was quite a bit different because we were chasing price at Q2 a year ago. So, yeah, so that was a big factor. Sequentially, as we look to the back end of the year, we're highly positive about it. We do put guidance out there. You know, we always endeavor to put guidance out there that we think we can reach, for sure. We don't ever want to put something out there that is a stretch for us. So to your point about conservative versus aggressive, when I characterize it as conservative, I put it on that scale the same way we always do it. We put a very reachable number out there, and then the management team works hard to exceed it. I mean, that's what we do. You know, we've been pretty successful doing that over the last couple years in particular, and we're going to be, you know, locking and loading, trying to do that again in the back six months of this year. But I just want to make sure you understand that we're not signaling anything negative, quite the contrary about how we feel. No, no, that's not where I was going.

Just to dovetail with that, and if you do the math, so the first half, our EBITDA combined was about a 13%. So forget the U over your comps. Let's talk sequential. The first half, we're about a 13.2%. The back half of the year, we're about a 13.5% if you take the midpoint of our sales in EBITDA. So to Jerry's point, are we conservative? You know, we certainly don't try to get too far ahead of ourselves on guidance. But on the flip side, we do have some back-end growth in terms of EBITDA. The tail end of the year, November, December, we do tend to see some seasonality kick in the long way. So I think, again, our numbers are, you know, Closest to the fin, basically, we can get right now with maybe, to Jerry's point, some conservatives and big fins. Excellent.

And the other kind of element to this mosaic that's relatively new is some of the maybe sequentially, we haven't seen any, obviously, manufacturer announcements, and then we get maybe some potential for deflationary types of behavior from manufacturer suppliers, and it's in the midst of some new loose-fill capacity being layered on in a couple years as well, next year or two. But at the end of the day, how do you think about the prospect of deflation, maybe in the near term, within your model? I think you mentioned it in a cautionary way for the distribution business, but for the overall business, how do you think about managing around that dynamic in your model now?

So, Justin, this is John. So when we think about our input costs, and I'll start with materials, so certainly if capacity – gets looser, the opportunity for a reduction in material exists. And we'll have to play that by ear and see what happens. So I think the only flip side of that, though, is we obviously have a labor component on the true team side of the business. And let's assume capacity is looser and labor tends to be a little bit more plentiful. That obviously puts a little bit of pressure, I think, on one of the good levers we have, which is tight labor. So, you know, you've got to balance both of those and understand it. And, listen, we do it day in and day out. We do it by location, which I think is an important comment because, you know, we always talk nationally, but, you know, we run this business locally. And so we just deal with that on a day-to-day basis. So there's puts and takes, I think, on inflation when I go forward. Some positives, some could be detrimental. But, you know, we balance that, as I said, day-to-day at about 300 locations around the country. Yeah.

Okay, and then this is my last question. The free cash flow in the quarter was very strong. The conversion, excellent. Atypically strong from a seasonal standpoint. Within the mosaic of your overarching guidance, how do you think free cash flow generation looks for the year?

Yeah, we don't provide that level of guidance. Having said that, I think I'll just leave you with the back half of the year for us tends to be more robust than even the first half. A lot of that tied to the seasonality I talked about where the AR bucket tends to get reduced basically towards the back if we get to nice free cash flow generation. Like we always say, this model is excellent in that we don't require much re-input of our positive cash flow back into the business to support the growth, whether it's CapEx or working capital. You know, we're always pretty optimistic about the ability to generate free cash flow. I think the other thing in the second quarter, our capex a little below our historical balances. You know, a lot of that's just timing, basically. But, again, we feel great about the back half of the year in terms of free cash flow. Excellent. Thank you, guys.

Our last question comes from the line of trade rooms from Stevens, Inc. Please go ahead.

Good morning. Thank you for squeezing me in here. mine are going to be well my first one is around the commercial side um you know you mentioned the backlog continuing to be very robust you know bidding into 2020 and 2021 if you could i guess both on the backlog as well as kind of the the longer term bidding opportunities you're seeing out there if you could give us a little more color on the types of projects you're seeing um You know, is this looking more on the light commercial side or the heavy side, both, you know, backlog and bidding opportunity?

Hey, Trey, it's Robert. So, you know, on the backlog side, obviously the lighter commercial jobs, which we refer to, light commercial jobs, which we refer to to be similar to, you know, residential, those jobs are more, you know, in the next three to six-month timeframes, whereas the heavy commercial jobs are probably more in the 12 to 18, maybe 24-month timeframes. So that's kind of how they look. flag, if you will. But, you know, I'd say it's really a variety of projects of all scale and size. And we've got some major, I'd say, you know, stadium-type work that's coming up. We've got major, you know, high-rise work that's coming up in larger metropolitan areas. And then we've got, you know, nice line of sight to light commercial work at the local, that our local, you know, residential branches across the country participate in. So it's really a variety. I think I think the point that we want to leave is just really good momentum in the business, and we put more focus on it. We put more dedicated resources on it. We put more leadership resource towards it as well, and the team's just done a nice job of using those resources and focusing on it. And quite honestly, everybody sees it as a good balance of business, both at the local level and at the regional level as well. So I think we've done a good job of stepping into the business, learning the business. We've been in it for a long time, but then learning it in new regions of the country and continuing to grow it. And then I think we bring a unique value proposition there, and our unique value proposition is we're bundling multiple products and multiple trades for the large contractors in these larger jobs, and they like that because now they don't have to deal with six or seven or eight different subcontractors. They're able to deal with one national player that can bring to them the stability and the expertise to perform the job very well in a very highly trained, safety-focused workforce that really takes a lot of headache off of their plates. So that whole value proposition is playing really well for us in commercial.

Well, thank you for that. And with all of the, you're obviously seeing market share gains there on the commercial side, and you're throwing a lot of talent and manpower at that and focus. So is it your expectation that you could see that commercial piece continue to grow as a, you know, in the overall mix as you consider, you know, your outlook for residential and then, you know, what you see in commercial today kind of taking more of the overall mix from the 22-6 where it stands today?

Yeah, I think we, as we mentioned, we see long-term growth here at a, you know, sitting at a plus or minus 10% share of $5 billion today. You know, we're going to continue to put, you know, effort, resources towards you. We feel like we're building new competencies. So, yeah, relative to the total top build mix and, you know, even distributing more products in the commercial space as well, we absolutely expect it to become a richer mix of our total top build business.

Okay, so that leads me to my last question, which is would that be in the case longer term, you know, with commercial becoming a bigger part of the mix? How do you think about that 25% flow through target kind of longer term, understanding that the commercial can be accretive to that? Thank you.

Yeah, Trey, this is John. So we're going to stick to our guns on the 22 to 27. I think what you could argue, and we would say, is that the more that commercial drives up, the higher end of that range becomes more probable. But again, the 22 to 27, you know, based on the fact that mix ebbs and flows, et cetera. But assuming a commercial drives a more significant piece, as it has in the past two or three years, then the higher end of the range becomes more of a probability.

Great. Thank you for taking my questions.

You're welcome.

There are no further questions on the phone lines.

Thanks, everybody, for joining today's call. And we look forward to reporting our third quarter results at the end of October.

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.