Welcome to TopBuild's Third Quarter 2015 Results Conference Call. My name is Beth, and I will be your conference operator today. [Operator Instructions] As a reminder, this conference call is being recorded..

I would now like to turn the conference call over to Mr. Sam Levenson. You may begin. .

Thank you, Beth. Good morning, and thank you everyone for joining us. We will be making references during -- from this call through presentation, which is available on the Investor Relations section of our website at www.topbuild.com..

As shown on Slide 2 of the presentation, many of our remarks today contain forward-looking statements based on current expectations. These forward-looking statements are subject to known and unknown risks, including those set forth in our third quarter 2015 results press release and our registration statement on Form-10.

Should one or more of these risks or uncertainties materialize or should underlying assumptions or estimates prove incorrect, actual results may vary materially from those we express today. In addition, some of our remarks today contain non-GAAP financial measures as defined by the SEC.

You can find reconciliations of the non-GAAP financial measures to the most comparable GAAP measures in a table with the third quarter 2015 earnings press release..

At this time, I'd like to introduce Jerry Volas, Chief Executive Officer of TopBuild, who will lead our discussion.

Jerry?.

Thanks, Sam, and good morning, everyone. Joining me on the call today are Robert Buck, our President, COO; and John Peterson, our CFO. We'll discuss our third quarter and 9 months financial results and share our views of the new home construction industry..

Let me start with a high level review of our financial results, so please turn to Slide 4. Our company continues to execute well within the improving housing environment. Top line growth accelerated in the third quarter to 7.6% over the prior year quarter, bringing the first 9 months in 6.8% ahead of last year.

Both TruTeam and Service Partners recorded revenue increases, with TruTeam revenue growing a healthy 8.7% and Service Partners revenue growing a solid 5.4%. As expected, TruTeam's top line 9.4% year-to-date growth aligns well with the year-to-date increase, unlike housing starts.

Over the long term, light [ph] housing starts are a good indicator of the environment within which we operate, particularly for our installation business and to a lesser extent our distribution business..

Bottom line results for the quarter were also strong with adjusted gross margins returning to 22.2%, as we continued working with our customers on pricing. SG&A on an adjusted basis improved significantly under our independent cost structure.

Overall, the drop-down adjusted EBITDA margin on incremental revenue was 20% for both the third quarter and the 9 months year-to-date..

On an adjusted basis, net income per share increased 56% to $0.50 per share. We'll also generate significant free cash flow, ending the quarter with available cash of $108 million..

Results reflect the strong execution of our team and the many advantages of our operating model. Our nationwide footprint that gives us scaling efficiency, 2 channels to the builder with both installation and distribution and strong relationships with the manufacturer that enable us to offer competitive pricing to our customers..

Moving to the next slide. Regarding the current housing environment, homebuilders are facing labor shortages, which are extending the normal building cycle. For TopBuild, this is extending the traditional 90-day lag time between a housing start and the installation work done by our team.

In addition, the multifamily segment, with its traditionally longer lag, continues to be a strong percentage of total housing starts. Overall, we continue to be optimistic on housing and expect the current moderate pace of improvement continue for several years as we move to at least the historical average of 1.5 million units.

The current headwinds of credit availability, student debt and labor shortages are moderating the rate of recovery, but also extending the recovery cycle. We believe the pent-up demand for housing is real and will eventually be satisfied with higher levels of new construction.

This is a terrific environment for the TopBuild model with our nationwide footprint, and we will continue to execute well on our firmly established residential space. We'll supplement this growth with a more significant percentage increase in the commercial space as we improve our mid-single-digit share of this business..

Let me now turn the call over to Robert Buck, our COO. .

Thanks, Jerry. I would like to welcome everyone who is participating in the call. We appreciate your interest in and support of TopBuild..

Turning to Slide 7. Let's review the achievements of TruTeam and Service Partners for the quarter. As Jerry mentioned and as expected, we made further progress aligning our material cost increases and customer pricing over the quarter.

Looking forward, the manufacturers have recently announced that they're deferring the next price increase from October 1 of this year to January 1, 2016.

We fully expect that we will see the historical pattern of some distribution customers prebuying ahead of the increase, and that over time, we will appropriately pass along these increase costs as realized..

Top line results for TruTeam accelerated in third quarter, reflecting solid execution. TruTeam results were driven by a residential performance with low double-digit growth in new construction, partially offset by diminished weatherization funding-type utility companies and local agencies within the repair of remodel business.

TruTeam also realized increased sales volume in the commercial business..

Service Partners delivered solid results on increased construction activity. Results for Service Partners also reflect strong installation performance and higher intercompany sales, offset by a slower roofing business..

I would like to discuss the commercial opportunity at TruTeam in a bit more detail. Right now, TruTeam has the capability of doing light commercial work nationwide. Examples include chain restaurants, retail and other smaller footprint commercial spaces. This represents a growing business for us.

In addition, we're also increasing capability in heavy commercial, which is typically multistory buildings on large projects with industrial applications. We're doing these types of installs in about 15 of our operations, and we expect to expand this significantly over time through both organic growth and targeted acquisitions..

If you turn to Slide 8, you'll see just a few examples of our commercial successes. This quarter, our team began work on the MGM Casino in National Harbor, located outside of DC, and we'll soon start work on One Lincoln Tower in Bellevue, located outside of Seattle.

We're also finishing a very large project as part of the $400 million renovation of the Daytona International Speedway. Our teams are providing a variety of services and products on these very visible commercial projects..

Turning to Slide 9. I would like to spend a minute discussing our operational execution and how we're changing as a business since the becoming TopBuild on July 1. I want to start by discussing labor. Labor continues to be a challenge, not only in the building community, but also for the industry as a whole.

Fortunately, it benefits a slight number of regions. I'm proud to say that we are the employer of choice in this industry with our emphasis on safety, training and our total rewards package.

There is no doubt the labor issue within construction, creates [ph] in general, is extending the build cycle, both in single-family and very visibly in multifamily. We experienced this in Q3, and we expect the same in Q4. At TopBuild, we understand that construction is a very local business and value is generated at the local level.

Towards that end, our local contracting and distribution teams have excellent local relationships cultivated over many years in each of their respective markets. We continue to aggressively manage costs and diligently evaluate opportunities to work efficiently and simplify the business..

Our strong focus on enhancing our local customer service was recently recognized by KB Home, who named us a top service provider at their Annual Strategic Supplier Conference..

On the TruTeam contracting side of the business, I'm pleased to announce that Steve Raia has rejoined our executive team to help drive our local operations execution. Steve is a pioneer in the contracting business and well known throughout the industry as a great operator focused on growth and execution.

Steve will work closely with our operation's team as we continue to simplify the business, execute well locally and build upon our strong local relationships. Our team welcomes Steve back to the business..

Prior to turning the call over to John, I'll like to thank every 8,000 employees across the country for their hard work, dedication and focus on working safely to deliver great value and service to our customers every day..

With that, let me turn things over to John to discuss financial results for the quarter. .

Thanks, Robert. Jerry and Robert provided some headlines on TopBuild's third quarter financial performance, and now I'll take you through a more detailed discussion.

I'll be reviewing overall sales and profitability for TopBuild, segment results, SG&A performance, operating income, adjusted EBITDA, EPS and a review of the effective tax rate for the third quarter. Finally, we'll review our overall working capital, cash flow, CapEx and cash position..

Moving to Slide 11. TopBuild's revenue increased 7.6% to $428 million, driven by growth in both the Installation and Distribution segments. Residential and commercial contributed to the topline growth, as did improved pricing, which was one factor driving our adjusted gross margin rate back up to 22.2% for the period.

Adjusted operating margins came in at 7.3%, a 170 basis point improvement from prior year. Margins improved due to volume growth, lower depreciation expense, lower corporate overheads and cost reduction activities. Adjusted EBITDA for the quarter was $36 million, a 21% improvement year-over-year..

Moving to Slide 12. TruTeam, our Installation segment, delivered third quarter revenues of $279.8 million, an 8.7% improvement over prior year. Major drivers were growth in residential new construction, commercial and improved selling prices. Year-to-date, TruTeam has grown 9.4%, which tracks closely to like starts on a year-to-date basis.

Adjusted operating margins for TruTeam were 7.8%, a 280 basis point improvement over third quarter 2014. TruTeam's top line growth and strong volume leverage, lower depreciation and cost savings initiatives all contributed to the improved margins..

Please turn to Slide 13. Service Partners' third quarter revenue rose 5.4% to $170.9 million. Topline growth was achieved through increased sales to external customers and the installation channel. Service Partners' third quarter operating margin was 9.9%, 60 basis points above prior year, driven by volume leverage and cost reduction activities..

Next, moving to Slide 14, let's discuss SG&A. As we have mentioned previously, we had a significant asset roll off of our booked depreciation schedule at the end of 2014. So each quarter, our depreciation and amortization will be approximately $3 million less than the prior year.

In addition, now that we are fully separated from Masco, our public company cost recorded each quarter as opposed to the Masco corporate overhead allocations reflected in our results each quarter prior to June 30, 2015. So this slide depicts normalized operation.

On an adjusted basis, SG&A expenses declined by $2.6 million year-over-year to $63.8 million, representing 14.9% of sales or a 180 basis point improvement. The reduction was primarily due to lower depreciation and amortization with all of other expenses essentially flat..

Moving to Slide 15. Adjusted earnings per diluted share using a normalized tax rate of 36% were $0.50 for the third quarter compared to $0.32 per share for the prior year..

Please turn to Slide 16. Starting with CapEx, through 9 months, the company has invested $10.6 million in capital spending, in line with our guidance of investment at or around 1% of sale.

Working capital as a percentage of sales at the end of the third quarter declined 110 basis points from prior year, largely due to improved accounts payable performance.

Moving to operating cash flow, the company had a source of cash flow of $43.2 million in the first 9 months of 2015 as compared with the source of cash flow of $39.7 million in the prior year. The improvement was driven primarily by stronger earnings.

At the end of the second quarter, we had over $108 million in cash on the balance sheet, which, coupled with our acceptable revolving credit facility, provides TopBuild with $176 million in liquidity, up $45 million from second quarter 2015..

Looking ahead to the fourth quarter, I want to remind those of you who modeled the company of 2 items, which impacted the fourth quarter of last year. First, as those of you who followed Masco at that time might recall, there was a brief discussion on their Q4 2014 earnings call about an insurance adjustment in our business.

The benefit to our company was approximately $5.2 million, which was reflected in gross margin in the fourth quarter of 2014. Second, as we pointed out in our second quarter 2015 10-Q, TopBuild was incorrectly allocated a favorable legal settlement belonging to another Masco business unit in fourth quarter 2014.

As a result, SG&A was understated and operating profit was overstated by $1.9 million. Since the error was not considered material to the previously reported 2014 financial statement, the correction was made as an out of period adjustment in first quarter 2015.

As a result of both of those items, gross margin and operating profit comparisons will be more difficult in the fourth quarter of 2015, and this will negatively affect our incremental operating profit and EBITDA margin. Just to clarify, these adjustments only impact our year-over-year comps, not our sequential performance..

Moving to income taxes. Our effective tax rate for the 3-month and 9-month periods ended September 30, 2015, is somewhat distorted from the 36% normalized tax rate we would expect. This is due to Masco's utilization of the net operating losses, which existed at the time of the separation and the change in the valuation allowance.

As a result, the effective rate for the quarter was 42%. As discussed previously, we expect that continued improvements in our operation will result in the objective positive evidence to warrant a reversal of all or portion of the valuation allowance for U.S. Federal and certain state jurisdictions by year-end 2015.

Just to reiterate what we have said on many occasions, it's anticipated that a significant portion or possibly all of TopBuild's U.S. Federal net operating loss carryforwards will be utilized by the Masco Consolidated Group through December 31, 2015.

Therefore, we continue to advise that our tax rate for 2016 and beyond is expected to be at or near 36%. Overall, we're pleased with our third quarter performance..

And now operator, we're ready for questions. .

[Operator Instructions] Our first question comes from the line of Scott Rednor, Zelman. .

First question, appreciate the color on the residential and commercial splits.

I'm just curious, do you guys have a measure to track your internal backlog? And can you give us a flavor for how much that's up year-over-year versus the revenue growth given the delays that you're seeing in the construction channels?.

Yes. Scott, this is John Peterson. The areas we can really see a good backlog is -- will be the commercial side of the business and the multifamily side of the business. I would say in both cases, they are stronger than a year ago.

On the residential new construction side, typically, you have a line-of-sight to about 1-month out, 1 month to 2 months out in terms of single family type of performance. So -- but again, we are seeing strong across all levels, but certainly, on commercial and multifamily are stronger backlogs than a year ago. .

John, is it the growth outpacing what you reported on revenue?.

In terms of what? The third quarter performance?.

Sure. However, you want to look at it.

Is your backlog trending higher than the growth you're reporting in terms of sales?.

Yes. I'd say right now we're tracking very close to what we were in the third quarter year-to-date performance. .

Okay. And then, on the -- from a capital allocation standpoint, I know you guys -- I believe you just had your first board meeting.

So maybe you could give an update there, John, given that at the end of the quarter, you're about 1x levered on a net debt basis?.

One is we did see a growth in the cash balance as we reported. We did talk about M&A as being one of the areas we're going to look at on a go-forward basis. So when we think about the first half of the year through the third quarter, lots of work around the spin, lots of new resources in place, new processes.

So most of that for the most part's behind us. So we're now in the process of starting to evaluate certain merger and acquisition activities. And that's probably the next area you'll see in terms of usage of capital, usage of cash on a go-forward basis.

In terms of additional capital allocation options, they are a little bit longer term in terms of our discussion. .

Scott, this is -- Jerry here, Scott. On the M&A side, as we have spoken about that before, we're going to be strategically looking at potential acquisitions that supplement our footprint. We think we've got a great national footprint. So both on the residential and the commercial side, same story.

We'll be carefully evaluating different opportunities, and we're going to be wanting to pick those opportunities and use our cash wisely for those that are going to supplement our existing nationwide footprint. So that's how we continue to look at that. .

Your next question comes from the line of Mike Wood, Macquarie Securities. .

Just curious if you can elaborate a bit more on that extended building cycle that you were referring to, potentially by geography where you're seeing it, and if you're looking at a matter of weeks, months or quarters in terms of the labor delays?.

Hey, Mike, this is Robert. Relative to the extended cycle, I mean, we're seeing it definitely on single family and very visibly on multifamily, as I mentioned. We see multifamily projects pushing out now, projects that we bid maybe up to 12 months ago, now that are just coming into work for us. We're seeing the multifamily extend longer.

Some of those projects are getting pushed into 2016. Single family, I think the builders would say there's days being added if not weeks and some of it's depending upon the region in the country.

So relative to region of the country, labor slowdown, we would say, the Northern California area as an example, Denver call out [ph] specifically, Texas is still a solid market, and we still see some labor challenges there and some extensions, especially on the multifamily side.

If I move up the East Coast, the Mid-Atlantic area up into the Northeast some as well, and some of that's just a push of work from the winter now hitting in that seasonally busy time here in the fall is driving some of that as well. .

Great. And you guys have done a good job on the productivity initiatives.

Just curious if you can give us some more color in terms of what that benefit is year-over-year? And if you can give us some guidance in terms of the SG&A going forward, if they're going to be at that $64 million run rate or what the seasonality is to that?.

Yes. We have spend a lot of time working, obviously, cost equation before the spin and post spin. We work on simplifying the business. We talked about in the past, Mike. I would say on a go forward basis, when we think about the additional cost that we brought on as part of the spin, most of that is on board in the third quarter.

We had a lot of those resources obviously coming on board prior to the June 30 spin date in advance of the spin. So most of that investment is reflected in our third quarter results.

I think on a go-forward basis, the best guidance I can give you, since we don't give specific guidance, is that we intend to manage that fixed overhead base, certainly in SG&A, and lever the business as we shown we've done in the second and third quarter performance.

So we have a footprint in place we talked about through 1.5 million starts and above, and again, we're pretty comfortable in terms of the leverage opportunities with the business on a go forward. .

Great.

Just finally, can I just ask if in the quarter, you were neutral on price cost or was it still a drag in 3Q?.

Yes. This is John, again. I think you recall last quarter, we actually had at 100 basis point gap in our gross profit quarter year-over-year. Third quarter was [indiscernible] even on an adjusted gross profit basis versus prior year's.

So we did a nice job of continuing to balance that pricing material equation that we talked about in the second quarter. So nice improvement in the third quarter for the business.

And again, we talked about this last time also, we expect to continue to try to improve that process on a go forward basis and show some expansion on our gross profit percentage. .

Your next question comes from the line of Keith Hughes, SunTrust. .

Yes. Just kind of building on the last question.

If you look within the installed segments of the 9% growth, how much was that with volume and how much was the price mix in the revenue?.

One of the things you're going to see -- this is John, again. One of the things you will in the queue specifically is from a TruTeam standpoint. We did call out low single-digit growth on the pricing side for TruTeam. And again, part of that recovery we talked about on the gross profit in the quarter.

I'd say Service Parters was flattish in terms of pricing improvements over the year-over-year. So in total, about a 2% improvement for the overall company in terms of pricing year-over-year in the third quarter. .

Okay. And you'd refer to your prepared remarks around Service Partners with the delayed price increase coming at the beginning of the year, I assume you're alluding to there could be a prebuy here in the fourth quarter.

Given the fact in installation, the price increases have been pretty small so far this year, how strong do you think you would see prebuy activity in the channel?.

Hey, Keith, this is Robert. I think it will be interesting to see, given that we've had this lag pushout. Seasonally, demand is strong, so we're seeing some more pushout. Depending on the weather, that could create a strong first quarter or strong end of the year heading into beginning of next year. So we don't see that prebuy yet.

We'll see that more in the mid-November -- late November type of timeframe. But given some more getting pushed out and if weather stays good in the December, we definitely expect to see some of that prebuy activity. .

How much can Service Partners customers, I mean, how much can they prebuy, how much can they warehouse?.

I would say probably on average key to average again, probably a couple of weeks’ worth of inventory, 2 to 3 weeks of inventory is probably what that can prebuy on average. .

Okay. And I guess, final question, you have alluded to all the elongated bill cycles in both multifamily as well as in single family, and you're not alone in talking about those. I guess, the question is, well, given that we're heading into the off-season where weather plays a roll and things like that.

The catch-up associated with that, that feels like a spring issue.

Would you agree or disagree with that statement?.

I think you're right. I think it could be that March, we typically see things start to break and pick up depending on how hard January and February is, but yes, we would expect that to see a late first quarter earning second quarter type of catch up. .

[Operator Instructions] Your next question comes from the line of Ken Zener, KeyBanc. .

This is actually Adam on for Ken. I'm just wondering if you might be able to comment on how much the slowdown in completions impacted your 3Q results. And if there is only a portion, let's say, of the quarter, if we should see more of an outsize impact in 4Q or about the same? And then, second, I attribute some D&A to each of your segments.

Distribution, install, and you seem to be getting about 25% to 30% incremental EBITDA margin, which is excellent.

And I'm just wondering if, A, that math this in the ballpark? And then, B, if that's sort of the range we can expect going forward?.

This is John, Adam. From an EBITDA standpoint, again, we're not giving guidance on the individual segments that we report on. The guidance we've shared is on a long-term basis. We're very comfortable on the 20% type of EBITDA pull-through on our incremental revenue.

As we told you many times, that's going vary by quarter potentially, but on a long-term basis, we are comfortable with that. The other thing we've shared on that topic is that if you think about the different segments, you would expect, on the TruTeam side, we'd see higher leverage because of the higher fixed cost base.

And on the Service Partners side, typically less than south of the 20 because of the higher variable cost in that business. So that's from a D&A standpoint.

In terms of the slowdown in completions impacting third quarter results, I think the real issue there is we talked about 2 things in Robert's portion of the script that we talked through, one is the impact of labor and what that has on the industry in total.

And the other is the fact that we're seeing a higher year-over-year multifamily content in terms of the overall units being put in play. So that higher multifamily, they tend to come at a longer lag cycle. And of course, the labor in certain parts of the country is helping to push out that cycle.

So I think Robert also commented, we'll start to see that as we get seasonally slower. We'll start to see that pulling in a little bit in the fourth quarter and then potentially ramp up or start to extend again in the first quarter as the seasonality kicks in. .

There are no further questions. I will now turn the call over to Mr. Jerry Volas for closing remarks. .

I'd like to thank our team members for their support and their commitment to drive our success. We're pleased with the results of the third quarter, which reflects a continued solid execution of our team. And we remain optimistic regarding the future of the new home construction industry and our performance within this environment.

We appreciate your interest in TopBuild and look forward to seeing many of you at the Deutsche Bank and Bank of America Conferences in December. Thanks again for joining us today. .

This concludes today's conference call. You may now disconnect. Thank you..