TopBuild Corp.

Greetings.

Welcome to Top Build's first quarter 2024 earnings release. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. I will now turn the conference over to your host, PDI Aquino. You may begin.

Good morning, and thanks for joining us. On our call today are Robert Buck, President and Chief Executive Officer, and Rob Coons, Chief Financial Officer. We've posted our earnings release, senior management's formal remarks, and a presentation that summarizes our comments on our website at topbills.com. Many of our remarks today will include forward-looking statements which are subject to known and unknown risks and uncertainties, 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 any forward-looking statements because of new information, future events, or otherwise. Please note that some of the financial measures to be discussed during this call will be on a non-GAAP basis. The non-GAAP measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. We have provided a reconciliation of these financial measures to the most comparable GAAP measures in a table included in today's press release and in our presentation, both of which are available on our website. I'll now turn the call over to President and CEO, Robert Buck.

Good morning, and thank you for joining our call today. Our first current performance got the year off to a solid start for Topfield and was in line with our expectations. As a result, continue to demonstrate the strength of our business model and our team's ongoing drive to improve. As you saw in our release this morning, we are also raising our outlook and guidance for the remainder of 2024, which Rob will cover in his remarks. Let me start with a couple of comments around our recent announcements. Most of you saw our press release of two weeks ago terminating the SPI transactions. Since last July, We worked through the HSR review process to help the DOJ better understand the entire business and transaction details. The DOJ focused on a small subsegment of metal building insulation, laminated fiberglass, and defined the business and distribution of the product very narrowly. Laminated fiberglass is one of several options that contractors have when insulating a metal building. This view from the DOJ led us to explore the possibility of renegotiating the transaction to buy SPI, excluding the MBI business. While doing so would have likely allowed us to receive regulatory approval, we were unable to agree on price with the sellers and ultimately decided that pursuing the transaction further was not in our shareholders' best interest. As good stewards of your capital, we will continue to be very disciplined in our approach to acquisitions and capital allocations. Next, we announced today that our board authorized a new share repurchase program of up to $1 billion. This is in addition to the prior authorization, which has approximately $154 million remaining. This brings our total availability for share repurchase to $1.15 billion. This authorization shows the strength of our balance sheet and our management team and board's confidence in our business and strategic direction. Turning now to our first quarter, we're pleased with the start to the year. Total company sales grew 1.1% to $1.28 billion and adjusted EBITDA rose 6.5% to $253.8 million. Good price realization of the quarter, coupled with productivity initiatives, drove adjusted EBITDA margin expansion of 100 basis points to 19.8%. On the same branch basis in the first quarter, our single family installation business improved sequentially each month. In fact, March was the first time in more than a year that single-family improved on a year-over-year basis, which is very encouraging. As you have heard from the public builder sentiment and order volumes being reported, we expect a healthy single-family environment for the remainder of 2024. Our installation results also benefited from continued strength in multifamily in the quarter, which grew more than 20% versus a tough top from last year. As we know, the last quarter starts and bidding activity for multifamily have slowed, but we have a healthy backlog of work that we anticipate will continue throughout the balance of 2024. Across the commercial and industrial landscape, we're seeing solid progress in the business and our bidding activity win rate continues to improve. Our proprietary lead app tool is driving organic growth in this part of the business. We see many major projects being bid and coming online. We have several heavy commercial mechanical installation projects that are being worked on across multiple verticals. We have added slides 9, 10, and 11 to our earnings deck so you can visualize these verticals as well as our highly fragmented $18.25 billion TAM or total addressable market. These slides will also help you understand our customer base, product breadth, and service reach. As you can see, we have a lot of white space across our core installation business for both organic and M&A growth. Turning to M&A, acquisitions will continue to be our number one capital allocation priority as they generate great returns for increased shareholder value. Identifying, evaluating, and integrating acquisitions is a core competency of ours, and we have an excellent track record of results in this area. We continue to have a robust pipeline of acquisition prospects. In fact, yesterday we announced an agreement to acquire Insulation Works, a $28 million Arkansas-based installation business with the national expertise in agricultural buildings. We're excited to have another great addition to the Topfield family of companies and expect to close this transaction later this month. To date, in 2024, we've announced five transactions totaling approximately $68 million in annual revenues. Let me make a couple of industry comments before turning to our operations. On the material supply side, fiberglass continues to be on allocation. We anticipate Knopf's new facility in Texas will come online successfully in Q3. However, there is quite a bit of maintenance and downtime planned at several other fiberglass facilities, which will likely offset any new production capacity this year. We are feeling the impact of tight supply situation in our distribution business, mainly our special distribution volumes, which Rob will touch on in his comments. On the other hand, we are seeing momentum with spray foam given the code adoption tailwinds I will discuss later. Recently, all four of the fiberglass suppliers have announced material cost increases effective in June or July. We expect to successfully work through any cost inflation that may take place. as we've consistently demonstrated. Moving to our operations, as I noted on our last call, we expanded our special ops team in 2023. This is a small team of highly seasoned operators whose mission is to focus on our branches whose metrics fall in our bottom quartile. By leveraging this team's knowledge and experience, we're able to identify opportunities to drive improved performance. This quarter, we saw the benefit of this special ops work in one of our larger distribution and fabrication locations on the East Coast. Through work that started in 2023, this business was relocated to a better geography to service our customers. The facility is right-sized to drive improvements operationally, including productivity and overhead. Better inventory management helped reduce transfers and improve service levels. Strategic decisions were made and actions regarding sales productivity and talent. Mix of business was reviewed and actions taken around new verticals for the business. What is the outcome? The special ops focus has improved profitability in this business from a low single digits to now mid-teens profit performance. The work on our bottom quartile is ongoing as we drive to improve our business, and our special ops team continues to focus on the opportunities across our network. Next, for those of you who might be less familiar, I'd like to spend a couple minutes on our mechanical installation business and the opportunity going forward. When you consider an industrial facility, they're full of pipes, ductwork, and mechanical systems. These environments may have systems that need to be maintained at a certain temperature or systems that require sound control via an acoustic barrier. It may also need protective insulation barriers to keep employees safe. We have the capability to supply any mechanical insulation solution required across many diverse industries. This is accomplished through a variety of products, including custom-fit jacketing and pipe covers made from insulating materials like fiberglass, foam glass, or aerogel, just to name a few. Our distribution business provides materials and custom fabricates coverings to contractors and mechanical installers. The standards for these industries are very prescriptive, often regulated with specific replacement schedules. We're currently working on several large industrial LNG facilities, liquefied natural gas, in the U.S. and Canada. Mechanical insulation plays a key role for LNG facilities. Many are being built along the Gulf Coast and you're dealing with high humidity environment and using cryogenic temperatures to compress natural gas. Let me give an example of a multi-year LNG mega project in Louisiana where we are a primary distributor of mechanical insulation. The facility will sit on more than 600 acres and take three to four years to complete. The facility will contain massive storage tanks, energy turbines, and multiple segments of pipeline totaling over 20 miles throughout. Some pipes will be more than three feet in diameter. Our initial scope included supplying products and fabrication services for modules being constructed offsite. Our national footprint allowed us to supply these pre-built modules for multiple distribution international facilities across multiple states. This represented over $12 million in revenue in 2023. As the project has progressed, our scope has expanded to include more hot and cold insulation applications, fire protection, and sound remediation installation for on-site construction, which will deliver an additional $20 million of revenue. This is a great example of our scope on a multi-phase project that enables us to leverage our product breadth and expertise Fabrication capabilities, project management focus, and national footprint. As we mentioned in the past, these projects may be lumpy over time in regard to revenue, but they play to Top Build's specialty distribution strengths. In addition, the replacement cycles for these projects vary from 18 to 24 months for certain equipment to plant-wide refurbishment every five years, so we will see recurring revenue from this project and others. Let me transition to discussing the future of our overall business. We have several dynamics across the industry that will allow our differentiated business model to continue driving profitable growth. Whether it be the large mega projects that should come online in the next few years and the recurring revenue that will follow, or our expanded commercial reach across North America. At a macro level, The United States continues to face a housing shortage, the result of the last decade of underbuilding. So fundamentally, we expect housing demand to be strong for the foreseeable future. We also see tailwinds for top building industry coming from energy code adoptions and recent HUD announcements. Given our expertise in all things insulation related, we expect these energy code changes to help fuel additional demand for years to come. All these dynamics, along with our relentless drive to improve and focus on talent, fuels our confidence that Top Build will outperform in any changing business environment. Finally, I'll close my remarks today by thanking and congratulating our entire Top Build team. Top Build has been recognized as a great place to work for the second consecutive year. This recognition demonstrates that we're building a workplace that supports development, provides career opportunities, ensures fair treatment, and values each employee. On behalf of our entire leadership team, thank you to our employees. Your passion, drive, and commitment to success have played a significant role in earning this certification once again. Let me now turn the call over to Ralph.

Thanks, Robert, and good morning, everyone. I want to thank our teams for their hard work in delivering another quarter of profitable growth for Top Build. As we mentioned on the February call, the first quarter of last year was our highest sales growth quarter due to the carryover of a strong single family backbone. We also had a slow start to this January due to weather across the country. Our teams came back and delivered strong And our first quarter saw sales grow 1.1% to $1.28 billion, in line with our expectations. Across both segments, we did a great job covering the fiberglass cost increases that hit during the quarter. These fiberglass price increases were partially offset by the carryover impact of lower material prices on spray foam from last year. Breaking our first quarter sales down by segment, our installation segment net sales grew 4.1% to $798.7 million, of which 2.6% was the net contribution from acquisitions and disposals. Pricing contributed 1.2%, and volume was up slightly by 0.3%. Installations multifamily sales remain strong due to the strength of our backlog and single family sales continue to improve each month of the quarter. The current trend on single family starts should be a tailwind to our business as we move through the remainder of the year. Net sales for specialty distribution declined 2.3% to 545.8 million for the first quarter. Volume declined 4.2% partially offset by higher pricing of 1.5% and acquisitions of 0.4%. The volume decline was driven by lower residential insulation sales because of business mix and tighter material supply of fiberglass. Total company gross margin of 30.3% expanded by 100 basis points versus last year due to improved productivity and higher pricing in both segments. As I mentioned earlier, our teams continued to do a great job effectively managing the price-cost relationship. In addition, our ongoing focus on driving operational improvements, as Robert detailed earlier, continues to drive margin benefits. Adjusted EBITDA of $253.8 million was up 6.5%, and adjusted EBITDA margin expanded 100 basis points to 19.8% compared to the first quarter of 2023. Installation adjusted EBITDA margin was 22%, an improvement of 60 basis points year over year. Specialty distributions adjusted EBITDA margin of 16.9% with 110 basis points better than the first quarter of 2023. Other income and expense totaled $7.5 million in the quarter, which was down from $16.1 million last year. Interest income from higher cash balances was the primary driver. Adjusted earnings per diluted share grew 10.3% to $4.81 in the first quarter. Turning to our balance sheet and cash flow, we finished the quarter with total liquidity of $1.4 billion, which includes cash of $968.8 million and availability under our revolver of $436.2 million. Net debt at the end of the quarter was $453.7 million, and our leverage ratio was 0.42 times the last 12 months adjusted EBITDA. Working capital as a percent of sales was 14% in the quarter, an improvement of 160 basis points from last year at this time, primarily driven by inventory reductions. Pre-cash flow for the last 12 months was $790.1 million, which compares to $502.6 million last year, an increase of 57.2%. Our uniquely advantaged business model continues to generate strong cash flows. Acquisitions remain our top priority for reinvesting our cash flow as our disciplined M&A process has a proven track record of driving significant shareholder value. As Robert discussed earlier, our board recently approved a new share repurchase authorization of up to $1 billion, bringing the total availability for buybacks to $1.15 billion. As we have done in the past, we will continue to balance returning capital to shareholders with our M&A pipeline. Turning now to our 2024 guidance, we are raising our sales expectations by $40 million to a range of $5.4 to $5.6 billion.

We are also raising money in our justice EBITDA guidance by $25 million to $1.065 to $1.155 billion.

and look across the landscape, I was wondering if you could give us kind of a breakdown of how you see the pipeline looking across the three segments that you laid out, and specifically within the mechanical industrial. Could you help us understand what the landscape looks like? I assume that the metal building insulation is not something which you expect to be an impediment going forward, but if you could just clarify that for us, that would be helpful. Thanks.

Hey, good morning, Steven. This is Robert. So, yeah, across the landscape of the pipeline, so I'll start residential first. So, very healthy there, both on the installation side and some good opportunity on the distribution side as well. And it can be, by the way, it can be fiberglass, it can be spray foam, the other insulation-related products that we do. That's why it provides such fragmentation and good opportunity. On the mechanical side, we definitely do not see the MBI as any inhibitor. That probably only takes one player off the table, and that was what transpired with SPI. Relative to mechanical, as we've said in the past, there's a handful of hand, if you will. After that, it's very fragmented. Regional players both in the U.S. and in Canada. And again, what you find in that space is those regional players may be participating in a certain vertical. So they may be in oil and gas. They may be in food and beverage. They may be in pharmaceutical as an example. That's why that space is fragmented as well, and it gives us a lot of M&A opportunity in that space. So good pipeline. That's why we it still definitely remains number one capital allocation priority, and I think you'll absolutely continue to see us be active across the space.

Okay, great. That's helpful. Appreciate that. Secondly, I guess with respect to the code changes, we saw HUD announce that change, which I guess would be effective in the residential new construction in about 18 months. moving to the 2021 code. So I was curious if you could help us dimensionalize that a little bit across a couple of vectors. First, is it right to think that this could, the code change to 2021 on a per-home basis, maybe increase the amount of insulation used, you know, in dollars, call it maybe, you know, 20, 30%? And then what would that translate into a benefit to top build? you know, from a revenue perspective in your view. And then another way of, another aspect is our understanding is that the 2024 code may be rather different.

And in many cases, it requires less materials. So, for me, it helps. Thank you. And then lastly, regarding the code change, what do you think the likelihood is that Fannie and Freddie adopt these changes too? is a tailwind for sure now obviously depends on a couple things one is where's the builder today if they're like in a 2009 or older code you know you could be talking somewhere in the ballpark of you know maybe as much of a 30% increase and maybe the

We know that insulation is one of the best and most comprehensive ways for builders to deliver and to meet those requirements as well. I think relative to adoption, I mean, you see that energy codes, it seems like they're just been really a boost of that tailwind, if you will, even though given the Inflation Reduction Act, 45L is a little more complex, but it takes more of a system to be determined. but it does seem to be, seems like in the past 12, 18 months, more tailwind for the industry for sure.

Okay, great. Well, it's all good news, I guess, for you guys. So thanks very much, guys. Appreciate all the help.

Thank you.

Thank you. Our next question comes from the line of Susan McClary with Goldman Sachs. Please proceed with your question.

Thank you. Good morning, everyone. Good morning. My first question is just, you know, perhaps going back to the capital allocation. Given your comments on the mechanical side of things, does it imply that maybe you would consider pursuing some of those smaller niche players rather than going after the handful of larger ones? And I guess with that too, how are you thinking about buybacks just given the increase in the authorization that you also announced this morning?

Good morning, Susan. This is Robert. I'll take the first part of that question. Rob will take the second part. On the landscape of the mechanical acquisition side, we're looking across both. Obviously, we have some relationships with some of the larger players and conversations that we've had. We participate across all those verticals. The local or more regional players that may play in one or two verticals, we're absolutely interested in that. You know, we've had some success in that approach in the past. DI had some success in that approach in the past as well. So we're open to the gamut on M&A relative to mechanical, and we think it's all, you know, open ground for us. So I think that's why we're excited about it. That's why we keep talking about the fragmentation, but also the robust pipeline as well.

Yeah, Susan, and I'll just add on the buyback front. I mean, obviously, you know, we're excited about announcing that today. It shows the confidence. you know, our board has in our strategy. It shows the health of our balance sheet right now. So, you know, as Robert said, you know, M&A is going to remain our top priority, but obviously given the, you know, the cash we have on hand today, we're going to balance that, balance our pipeline with, you know, returning capital to shareholders as we have in the past. So, you know, like I said, we're really excited about that and we're going to continue to manage that as we have in the past.

Okay, all right. Thank you for that. And then, you know, maybe thinking a bit about price and price cost. You know, you mentioned the announcements, the price increases that have come out from the suppliers. Just any thoughts on how that can roll through the business and your ability to continue to offset those incremental increases?

Yeah, this is Robert. So, you know, obviously competent. We've talked in the past about number one. how we manage those given our ERP system and that touch with each branch at the local level.

Two, I think we've demonstrated I think it's relevant to, you know, how that plays out, you know, to see how a single family starts. year relative to what happens with price and the price increase so more to come

dynamics, you know, more favorable price of supply was so tight, I guess, is one of the things I'm trying to understand as that goes to the perhaps tension that we might see in price in the second half.

Yeah, Ken, so I'll take the first part on material and Rob will handle the price detail piece of it. So, yeah, so material, you know, definitely still tight. I mean, I would say that, you know, we've had to buy some material through third party, if you will, get back in Some of that is planned maintenance, but there's also been some downtime in the industry as well, unplanned downtime in the industry that caused material to be tight. I think what we've seen is you see, given some of the code adoption, you're seeing some momentum with other products. We mentioned on our prayer remarks around spray foam. I think you see that relieving some of it relative to the installation side of the business. And then we talked about fiberglass. There was also some commercial products that were very tight in the first quarter as well, mainly around mineral wool and some of the manufacturer's issues of that product as well. But that's definitely improving. So we think material stays tight, but we think we'll be in a good position here given some of the other Rob, we'll talk about the price piece.

Yeah, so around price, Ken, I mean, the way to think about the first quarter, a couple things impacting that and probably making it a little less than if you just look at fiberglass in a vacuum. One is the time as we go into the second quarter. And then the other thing you have is the carryover impact of some price decreases we saw last year, primarily around spray foam. And that's going to continue on in through the second quarter. offsetting some of the price increase we see on fiberglass.

Okay. And then can we talk to, obviously the deal didn't go through, but mechanical is a huge area, right, where you can keep doing acquisitions given your mid-teen share for quite a while. But perhaps is there something different that as you do these mechanical acquisitions, acquisitions that will change the incremental margins of specialty distribution? Or is it still expected to largely be let's say 75% material, 25% perhaps value add, so the incrementals of that business over time will still be in that, you know, low to mid teen range that I think you guys have described before?

Yeah, I mean, I think from what we've seen, I think we'll expect, you know, most of the distributors in that space will probably see, you know, EBITDA margins when we acquire them, kind of in that mid-teens type or low, I'd say more low, you know, 10%, 11% type range, maybe low teens. But then just like with DI, you know, and the synergies we'll be able to drive, we'd expect to be able to get that up into the mid-teens and the incrementals, Over time, once you get that first year fixed cost behind you there and you're leveraging that fixed cost base, we'd expect the incrementals to be in that 22 to 27 that we target. Over the long term, we talk about distribution being more towards the low end of that and obviously install more towards the high end.

Thank you very much.

Thank you.

Thank you.

Our next question comes from the line of Michael with JPMorgan.

Please proceed with your question. Thanks. Good morning, everyone. Thanks for taking my questions.

I just wanted to circle back for a moment. I don't mean to beat a dead horse here, but obviously a lot of focus around mechanical vertical.

And I was wondering if you could give a little more color around what the metal building insulation

uh as part of your your acquisition strategy within the broader space yeah michael this is rob i'll start on that one i mean when you look at mbi for for us today it's you know roughly about six percent of our revenue it's important to also clarify for people it falls into that that medical middle vertical or that middle market on our slide for the commercial building envelope it's not the mechanical space it's the commercial building envelope and from our view you know When you go to insulate a metal building, there's multiple options you can do, right? You know, laminated fiberglass is one option, and that's what we do, and that's what SPI did as well. For them, it was about, you know, 15%, you know, of their total revenue. So relatively small pieces for both of us. That's where it's a small niche within that commercial building envelope. When you go to insulate a commercial building, you could use laminated fiberglass, you can use spray foam, you can use insulated metal panels. And that's how we thought about the market more broadly, but the DOJ narrowed in on that laminated fiberglass, which is a much smaller piece of the overall market there. So in terms of our M&A strategy going forward, it doesn't really concern us. We're already a niche. And we're not as big a player in the rest of the commercial building space or in the mechanical space. And that's where we'll continue to do M&A going forward.

And obviously, Mike, that's where the focus was earlier on that small initiative, the MBI side. So no concern across the rest of the business. And there's really not much at the table relative to MBI other than the decision we just made.

Right. So I guess just kind of following on that and appreciate the additional color there. As you look at the landscape of potential targets across the commercial industrial space, the building envelope, and the mechanical, in the past you've kind of said that there were maybe you know, half a dozen or less kind of larger potential acquisitions, medium to larger, and you kind of walk through the different, you know, relative sizes. With SPI off the table, you know, to the extent that some of these other medium to larger size potential targets also have MBI, I'm just kind of curious if that kind of changes the – or the likelihood of some of those other larger players, or was this kind of a one-off where, you know, the other kind of larger, medium to larger targets wouldn't necessarily have this niche issue that the DOJ kind of zeroed in on?

Yeah. Great question, Mike, because this is Robert. So you hit on it there. The other players really don't have the NBI niche piece of the business. That's why we keep saying it's really zero concern for us from an M&A strategy perspective. So it doesn't really exist in any of the other targets that we've talked about in the past or, you know, any of the ones that we're focused on. So really not an issue.

Great.

And then one last quick point if I could. When you talk about the guidance, and you kind of said that it was driven off of the better first quarter process, I just wanted to clarify that

of the Arkansas installer, and also if it reflects any level of success with the June-July price increases.

Hey, Michael, this is Rob. So it does not include either one of those. We don't include any acquisitions that we haven't yet closed. Quick numbers and then Robert can, you know, expand on what's going on in the industry a little bit with spray foam. But from a unit basis in terms of the houses we insulate, it's probably, you know, roughly 10% on the unit spaces. From a dollar's perspective, though, it's going to be, you know, north of 20% because, you know, the cost on spray foams, you know, roughly 2X, maybe a little more than that, closer to 2.5 in some places in terms of the cost per unit. But Robert can talk a little bit about some of the dynamics there with spray foam right now.

Yeah, so you're definitely seeing momentum in the product shown. One is definitely a big tailwind coming from the codes that we've talked about. So you see even some of the production home builders are becoming very interested in that product to reach the 45L rebate piece and make sure they deliver upon that. So yeah, definitely momentum with the product, both smaller builders, custom builders, but then also even with production builders. And then, you know, last one I would just say is around commercial. We see more spray foam inspect in commercial projects as well. So it's got some momentum really across the board.

Got it. And then in yesterday's Insulation Works announcement, you guys specifically called out the agricultural market. Can you give us a rough estimate of how much that segment currently contributes to sales and then what you think the market opportunity is there?

For us today, it's a pretty small piece. We do that across the country in different parts. I think about the Northeast as an example, Southeast. We do it, but what we love about Installation Works and the ownership group there is they really are a national player in that, great relationships, great expertise. even with some of the large poultry producers across the country. So they're bringing in a whole new level, which will really be something we can build upon across the country for top build.

Thank you. Our next question comes from the line of Phil NG with Jefferies. Please proceed with your question.

Hey, guys. I guess my question is, do you have any chunkier deals in the pipeline, especially on the CNI side?

And just given how strong your balance sheet is and pretty big cash flow, perhaps, Rob, how are you thinking about pacing this buyback?

Because, at least on my math, I've done that with buyback, not saying you would buy the whole thing. this year, it would still get you to a balance sheet like one times or less from a leverage standpoint. So, one, you know, color on chunkier deals, and two, how are you thinking about facing this bill and dollar buyback authorization program if you stand on it?

Hey, Phil Roberts. I'll take the first part. So, yeah, I mean, definitely, you know, the pipeline looks good from that perspective. Obviously, we were waiting to see if we got the SPI across the finish line. And so now that we've moved forward from that, made our decisions that are remaining disciplined on the M&A front, then we'll be moving forward with some of our other opportunities that we have.

So feel good about that.