Thank you for standing by. This is the conference operator. Welcome to the Installed Building Products fiscal second quarter 2018 Investor Conference call. [Operator Instructions]. I would now like to turn the conference over to Jason Niswonger. Please go ahead..

Good morning, and welcome to Installed Building Products Second Quarter 2018 Earnings Conference Call. Earlier today, we issued a press release on our financial results for the second quarter, which can be found in the Investor Relations section on our website.

On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements within the meaning of the federal securities laws.

These forward-looking statements include statements with respect to the housing market, our financial and business model, seasonality, our ability to increase selling prices, our ability to manage employee related costs, the demand for our services and product offerings, expansion of our national footprint, products and end markets, our ability to capitalize on the new home and commercial construction recovery, our expectations for the residential end markets, our ability to strengthen our market position, our ability to pursue and integrate value enhancing acquisitions, the impact of Alpha on our revenue and profitability, expansion of our commercial business, our growth rate and ability to improve sales and profitability and expectations for demand for our services and our earnings in 2018.

Forward-looking statements may generally be identified by the use of words such as anticipate, believe, expect, intend, plan and will or in each case, their negative or other variations or comparable terminology. These forward-looking statements include all matters that are not historical facts.

By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future.

Any forward-looking statements made by management during this call is not a guarantee of future performance, and actual results may differ materially from those expressed and or suggested by the forward-looking statement as a result of various factors, including, without limitation, the factors discussed in the risk factor section of the company's annual report on Form 10-K for the year ended December 31, 2017, as the same may be updated from time to time in subsequent filings with the Securities and Exchange Commission.

Any forward-looking statement made by management on this call speaks only as of the date hereof. New risks and uncertainties come up from time to time, and it is impossible for the company to predict these events or their effect.

The company has no obligation and does not intend to update any forward-looking statements after the date hereof, except as required by the federal securities laws.

In addition, management uses certain non-GAAP performance measures on this call, such as adjusted EBITDA, adjusted EBITDA margin, adjusted net income and adjusted net income per diluted share, adjusted gross profit and adjusted selling and administrative expenses.

You can find a reconciliation of such measures to their nearest GAAP equivalent in the company's earnings release and additional reconciliation for adjusted EBITDA for earlier fiscal years in our investor presentations, which are available on our website.

This morning's conference call is hosted by Jeff Edwards, our Chairman and Chief Executive Officer; and Michael Miller, our Chief Finance Officer. I will now turn the call over to Jeff..

Thanks, Jason, and good morning to everyone joining us on today's call. I'm happy to have the opportunity to talk to all of you about our second quarter results. As usual, I'll start today's call with some highlights and then turn the call over to Michael Miller, IBP's CFO, who will discuss our results in more detail before we take your questions.

Record second quarter sales were driven by the contribution of our recent acquisitions and strong market demand for installation services. We experienced solid price momentum during the second quarter as we continue to actively adjust pricing with our customers. We are encouraged by our continued strong financial and operating results.

Demand for our services remains high and we expect 2018 to be another record year for IBP. So let's start today's call reviewing the positive momentum that is underway at IBP. The nearly 18% increase in revenues during the second quarter demonstrates this continued success of our growth oriented strategies.

Solid organic growth, the contribution of our recent acquisitions and improvements in the rate of single-family housing completions continued to favorably influence revenues. During the 2018 second quarter, we experience strong growth in our end markets.

In the quarter, single-family same brand sales increased 14.5% while total single-family sales increased over 22% compared to the increase in total U.S. single-family completions of 6.5%. Looking at the multifamily market, same-branch multifamily sales decreased approximately 1.5% while total multifamily sales decreased less than 1%.

The small decline in multifamily sales was a result of significant growth experienced in last year's second quarter and the lag between starts and completions in our core geographies. Same-branch multifamily sales are up over 55% from the 2016 second quarter.

Combined new residential same-branch sales increased approximately 12%, while total residential sales increased approximately 19%, compared to the increase in total U.S. completions of approximately 8%.

We expect residential end markets to improve towards stabilization of approximately $1.5 million total housing starts over the next several years and our business continues to benefit from the recovering housing industry. During the 2018 second quarter, total U.S. housing permits increased more than 6%.

We believe this points to continued strength in our residential end market, and we anticipate that housing will continue to benefit from various factors, including improving employment, rising household formations and strengthening consumer confidence. We continue to believe our focus on operating branches and strong and diverse U.S.

housing market's enhances opportunities and creates a favorable position for IBP to outpace industry growth. IBP's current footprint of locations provides us access to nearly 70% of total residential permits. We're committed to further expand our geographic footprint through our acquisition strategy as well as organic branch growth.

Diversifying IBPs product mix allows the company to provide more installation services to our customers, expands our end markets and deepens our relationships with builders across the country.

As a result of these proactive efforts to diversify our installation services, at June 30, 2018, approximately 66% of revenues were derived from insulation, installation services, compared to 76% of revenues at the second quarter of 2014. Acquisitions continue to play an important part in both our product and geographic expansion strategy.

And so far this year, we have acquired approximately $33 million of annual revenues across multiple product lines and markets. During the 2018 second quarter, we acquired H2H Blinds, LLC an installer blinds and shutters, primarily for the residential construction market in Georgia and North Carolina with annual revenues of approximately $7.5 million.

We also acquired two insulation installers during the quarter. In May of 2018, we acquired Green Star Plus Insulation, an insulation installer located in Southern Indiana with approximately $2.3 million in sales. Also in May 2018, we acquired Advanced Insulation, a spray foam and fiberglass installer located in St.

Augustine, Florida with approximately $1.3 million in sales. We have a strong platform of complementary installation services led by experienced and motivated team. This combined with strong operating cash flow and recently expanded credit facilities provides IBP with significant resources and capital to fund our accretive acquisition strategy.

The market for residential and commercial installation services remains highly fragmented and our pipeline of potential acquisitions is robust. We continue to pursue acquisitions that expand our geographic footprint, diversify our end market and further our complementary product offerings.

With this overview, I'd like to go into more detail about the pricing environment for insulation services. The second quarter operational performance at Alpha, our commercial installation business and why we are optimistic for the remainder of the year.

Previously, we have talked about the complex pricing and demand dynamics within the insulation industry this year. The increased demand for material to support industry growth as well as planned and unplanned downtime at manufacturing facilities have impacted industry supply and supported manufacturing pricing increase strategies in 2018.

I'm pleased with how our team has responded to these industry trends. During this effort to manage supply and source material for operations, no IBP branch has been without material and we've met our customers' needs for installation services.

Strong relationships with insulation manufacturers and IBP sourcing platform help us effectively navigate these challenges. As I mentioned in last quarter's call, we experienced accelerating price momentum during the month of March as a result of our ability to successfully negotiate better pricing reflective of these market conditions.

This revenue trend continued throughout the second quarter and attributed to price/mix growth of 5.5% compared to 2.8% for the same period last year and 3.6% for the 2018 first quarter. Given the current market environment, we believe we can continue to work to lessen the impact of rising material across all of our product lines.

Alpha's revenues have increased approximately 20% since we acquired the business in early 2017, predominantly due to the growth within existing Alpha locations and the expansion efforts to enter new markets over the past several months.

The combination of this sales growth and geographic expansion have resulted in incrementally more travel, employee training and production management cost to support these new locations and meet customer production schedules. As a result, these expansion branches have reported gross profit well below legacy branches.

While these expansion related impacts to profitability are temporary during the quarter, they negatively impacted the same-branch incremental adjusted EBITDA margin, offsetting the progress we've made to manage material cost inflation.

We are actively working to reduce these additional costs at the expansion locations, while we grow the revenue backlog and leverage branch cost. We believe that these efforts will help the new Alpha branch locations reach the levels of profitability experienced in our other branches.

Overall, Alpha has been a good acquisition that provides a strong platform of national relationships, the general contractors and product expertise in the large commercial end market.

We continue to believe in the long-term benefits of geographic expansion to support our existing large commercial construction customer base, despite the near-term impact on profitability.

So to wrap up my comments before turning the call over to Michael, we spent the last 12 months executing on our plan and despite the investment of time and resources in the future of Alpha, we've produced substantial year-over-year growth in sales and earnings in every quarter since our IPO.

This reflects strong underlying demand in our core installation business, the resiliency of our model and experience of the company's leadership team. That backdrop for the remainder of the year remains positive and we expect profitability will continue to improve from favorable pricing trends and the improvements underway at Alpha.

As a result, we continue to expect 2018 to be another strong year for the company. With this overview, I would now like to turn the call over to Michael, to provide more details on our second quarter results..

Thank you, Jeff, and good morning, everyone. For the 2018 second quarter, our revenue increased 17.9% to a record $332.6 million. Our same-branch sales increased 11.3% due to an increase in volume and favorable improvements in price and mix.

Our same-branch single-family sales growth was 14.5% and our total new residential construction same-branch sales increased 12.1%. Second quarter 2018 gross profit improved 12.6% to $95.6 million from $84.9 million in the prior year quarter. Adjusted gross profit as a percent of revenue was 28.9%, compared to 30.1% for the same period last year.

The decline in gross profit margin was predominately attributable to the timing of pricing material inflation to our customers and the incremental profitability impacts to support branch expansion in our commercial business, Jeff mentioned.

For the 2018 second quarter, selling and administrative expenses, as a percent of net revenue improved to 18.3% as compared to 19.6% for the 2017 period. As a percentage of revenues, administrative expenses were 13.5% in the second quarter compared to 14.8% for the same period last year.

Adjusted selling and administrative expenses as a percent of net revenue improved by 100 basis points from 18.6% to 17.6%. We expect selling and administrative expenses as a percent of net revenue to continue to improve over time as we further scale our operations and benefit from increased sales.

As we've stated in previous earnings calls, it is important to note that as our acquisition strategy continues and as the volume of total acquired business operations become larger, we will incur additional noncash amortization expense.

In the second quarter, we recorded $7.3 million of amortization expenses compared with $6.6 million for the period last year. This noncash adjustment impacts net income, which is why we continue to believe that adjusted EBITDA is the most useful measure of profitability.

Based on our acquisitions completed to date, we expect third quarter and full year 2018 amortization expense of approximately $5.2 million and $24.8 million, respectively. These figures will change with any subsequent acquisitions.

For the second quarter of 2018, adjusted EBITDA improved to $45.6 million, representing an increase of 16.2% from $39.2 million in the prior year. As a percent of net revenue, our adjusted EBITDA was 13.7% in the second quarter, compared to 13.9% in the prior year quarter.

Historically, the third reported quarters of the year are our most profitable and we expect 2018 will follow this trend. We continue to believe our financial model can return to full year mid-teens adjusted EBITDA margin as the housing recovery reaches stabilization.

Our same-branch incremental adjusted EBITDA margin for the 2018 second quarter was 12.5% compared to 25.3% for the same period last year.

The progress we have made to successfully improve pricing and mix in our core residential business as a result of recent material cost inflation has positively increased incremental adjusted EBITDA margin consistent with our expectations for the full year range of 20% to 25%.

However, commercial branch expansion negatively impacted same-branch profitability during the quarter, partially offsetting these price/mix gains. The current initiatives underway to improve profitability of our new Alpha branch location will continue for the remainder of 2018, meeting our branch profitability expectations in 2019.

The adjusted EBITDA margin contribution from acquired revenue was 12.9% compared to 14.8% for the same period last year. On a GAAP basis, our second quarter net income was $16.3 million or $0.52 per diluted share compared to net income of $12 million or $0.38 per diluted share in the prior year quarter.

Our adjusted net income improved to $24.6 million or $0.78 per diluted share compared to $18.7 million or $0.59 per diluted share in the prior year quarter. For the second quarter of 2018, our effective tax rate was approximately 24% compared to 33.4% in the prior year quarter. For the 2018 full year, we expect an effective tax rate of 25% to 27%.

Now moving on to our balance sheet and cash flow. For the six-month period ended June 30, 2018, we generated $33.1 million in cash flow from operations, compared to $28.4 million in the prior year. We continue to use our strong operating cash flow to fund acquisitions and reinvest in our business.

Capital expenditures at June 30, 2018, were $18.5 million, while total incurred capital leases were $814,000. Capital expenditures and incurred capital leases as a percent of revenue decreased 20 basis points to 3% at June 30, 2018, compared to the same period last year.

We continue to expect gross capital expenditures and incurred capital leases to trend at approximately 3% of sales during this part of the housing recovery. At June 30, 2018, we had total cash and short-term investment of $160.1 million compared to $92.6 million at December 31, 2017.

During the second quarter, IBP did not repurchase any of its common stock. We currently have approximately $25 million available in our $50 million stock repurchase program announced in February 2018.

In June, we successfully increased the size of our existing Term Loan B facility as well as our ABL Revolving Credit facility and extended the maturity of each of approximately one year.

The $397.8 million Term Loan B facility matures on April 15, 2025, has no financial maintenance covenant and is rated BB by S&P Global rating and B1 by Moody's investor service. The pricing remains the same at LIBOR plus 250 basis points with a LIBOR score of 1%.

Our $150 million ABL Revolving Credit facility matures on June 19, 2023 and provides enhanced bond availability against certain types of accounts receivable. [indiscernible] at June 30, 2018, with approximately $453 million.

Taking into account cash, short-term investment at June 30, 2018, our net total debt was $293 million compared to $255 million at December 31, 2017. Our capital structure remains conservative, and we have considerable flexibility as we continue to deliver on our growth strategy. With that, I will now turn the call back to Jeff for closing remarks..

Thanks, Michael. We continue to believe there are significant opportunities to meaningfully grow revenues and profitability. We remain focused on profitably growing our insulation and installation business, while further expanding our services to new geographies and markets and product lines.

IBP has a strong platform, disciplined approach and experienced team. We continue to believe profitability will demonstrate improving trends throughout the year as we benefit from better pricing with our customers. I'm encouraged by our continued record results and our opportunities to grow and create value for our shareholders in 2018 and beyond.

Operator, let's open up the call for questions..

[Operator Instructions]. The first question comes from Nishu Sood with Deutsche Bank..

So just wanted to ask Michael about your comment that based on the incremental same-store EBITDA performance that you saw during the quarter? You are comfortable based on what you're seeing with the normalized 20% to 25%? You're comfortable with that? Does that mean -- are you saying that for this year? Or are you saying once the price cost situation stabilizes, kind of considering 1Q normal -- I'm sorry, abnormal, that you get back to 20% to 25% when it is a normalized situation? So is it this year or is it the run rate?.

Thanks, for the question. Just as a reminder, we've talked about the same-branch incremental margins on a full year basis and not on any specific quarter. Historically, the incremental margin -- historically, this is not the case last year as you know would be highest in the third and fourth quarter.

Last year was a little unusual and that we had a very solid across all of our key metrics second quarter, but as I mentioned in my comments, we do expect that this year '18 is going to be a more typical year where we continue to see improving profitability through the second half of the year.

The one thing that we noted this in the comments that will weigh on the incremental margins a little bit is the investments we're making in the organic branch growth within the Alpha operations, which we are very confident in will pay and perform very well over time. But it is an investment that we're making in that business.

We think it's the right strategy to grow and balance out our portfolio with both the combination of organic growth and acquisition growth in that space. So we feel very good, particularly what we're seeing on the residential side of the business in terms of price/mix and also the volume growth that we're seeing there.

So yes, we feel confident about the 20% to 25% incremental margins on a full year basis..

So for this year? You're still saying that?.

As you know we don't provide guidance so I'm not going to say absolutely for this year, but I would say that we continue to see positive momentum in the business. And we feel good about the numbers that we have put out there relative to the incremental margin and also getting to a mid-teens EBITDA margin as we reach stabilization..

Got it.

And as we think about the -- there was a sharp inflection point that we haven't seen for sometime in insulation prices late last year, earlier this year, how has it trended since the last quarter since we first began to discuss this? Is it still -- has it kind of normalized the pace? Has it -- has the curve kind of bent down? Is it a more normal pace year? Just wanted to understand the kind of trajectory of what you're seeing since you last reported?.

You mean in terms of prices from the manufacturers or in terms of our ability to realize price increases from our customers?.

The prices from the manufacturers?.

Well, I think, as you know, I mean, basically there are three price increases announced this year one in January, one that was sort of March, May bifurcated and then there was one announced for August. And there continues to be, I think rigidity in the marketplace for those price increases.

And I think [indiscernible] spoke pretty heavily to those in their earnings release in terms of what their expectations are for price realization. So we feel that the market is going to certainly through '18, we're going to see a rising price environment on the material side.

And we're continuing to work with our customers to make sure that we recover that price increase. And one thing I would highlight is the price/mix that we had in the quarter.

It was one of the highest price/mixes we've had, that's reflective on the positive price momentum we are seeing, but also one of the things that negatively impacts if you go to price/mix and we talked about this for several quarters now, is that we saw very strong growth in our other products.

So the non-insulation products which grew at a rate higher then installation in the quarter. Because of those products the average selling price of those products are considerably lower in insulation, it actually mitigates the price/mix.

So we feel very good about what we're seeing in the business and while we still have work to do in terms of improving our selling prices to our customers, we feel good that the team is out there working hard to get that done..

The next question comes from Trey Morrish with Evercore ISI..

Looking at your gross margin it was down 120 basis points on that adjusted line year-over-year.

Could you quantify was that decline was due to this increased investment in Alpha? What was the price cost? And if any few other numbers that may have pushed that down on negative side?.

Yes, I mean, price definitely -- material price definitely influenced it, but there was more influence from the investment in the Alpha locations than material price, meaning that we were able to continue to work to raise selling prices to help offset the material price inflation.

While it wasn't 100% offset, it is definitely improving not only as we went from first quarter to second quarter, but throughout the course of the quarter.

If that makes any sense?.

That's good to hear that you're making progress against that.

And talking about these investments that you're making at Alpha, could you give us some examples of what you are doing tangibly there? And how do you plan on evaluating the success of these investments?.

The success of the investments comes from us getting the branches to a point where their profitability is consistent with what we would expect at a typical mature Alpha branch and a lot of that is volume driven.

So we like to have a branch get into the $5 million plus revenue range and get their margin sort of in what we talked about relative to that business and sort of a midteens-ish EBITDA or even higher EBITDA margins.

So we are working very diligently to make sure that all of the new locations that we have opened there won our bidding jobs effectively, making sure they are managing jobs effectively and getting to the volume that make sense that gross profitability in that business and it's an investment and it's one that we think is well worth making because it creates a much larger, more stable platform in that business on an ongoing basis and we think it's helps diversify our revenue and our cash flow stream..

This is Jeff Edwards. But, I mean it's really not fairly straight forward and obviously, when you open a new location, you don't have the revenue base there to support the overheads associated with opening a new location.

And so in addition to just a regular overhead that you carry at that location whether it's the facility or whether it's people and typically in terms of Alpha, we would open a location with both what we would kind of call a Mr. or Mrs. inside person or Mr. or Mrs.

outside type person to kind of go in and work at those branches and those are typically -- and these are people with experience and are not especially in today's environment, cheap and we don't have the revenue base to support that, obviously.

And then I guess further in addition to that from a staffing perspective in many cases, it's not as efficient early on when we open one of these locations as it will automatically be when we get kind of a core group built there and a core book of business.

So that we either dealing with some cases bringing in labor on kind of more spot basis and/or we're bringing labor from other branches that we have that are distance away, you got the costs associated with inefficiency there..

The next question comes from Michael Wood with Nomura Instinet..

Just was hoping, you could provide some more color on the Alpha investment in terms of how long you will be making these investments, the expansion investment? Do they weigh on second-half results similar to second quarter? And are they like chunky type investments or are these going to be just a steady case as you roll out the branches?.

Maybe they're steady in the sense that they -- you continue to have them until you stabilize them.

But we feel confident and as we said in our prepared remarks that we are trending them towards the profitability of the other locations such that we think that they will be where we'd expect them to be in 2019, but we do believe that the pressure that they put on the second quarter will mitigate or come down a little bit in the second half of the year.

Although some of that will be still there, but we feel by '19 that we'll have them at a point where they are more consistent with what our expectations would be..

Okay, and last quarter, you said that you expect the price cost return to a tailwind by year-end? Is that still the case with the additional price attempts like the August attempt? Can you just update us there?.

Yes, I mean, I think we have consistently said we are supportive of the rising price environment. And this year is a little atypical. As I think we've talked a lot about and that there were three price increases where that were announced that have rigidity around them, whereas -- I mean that hasn't happened in years.

So it does make it a little bit of more challenging with us and our customers. But ultimately that pricing momentum we believe is very positive..

Okay.

And just finally, is the lag price that you're seeing just simply a timing issue of when the contracts rolling off? Or is there a difficultly passing through price when you actually or at the time of price discussion with the customers?.

It really is a customer by customer almost subdivision by subdivision negotiations. So it really depends, I mean, in some customers, we may give them just one price increase, a large price increase in a year that we expect to cover all price increases that would take over the course of the year.

So it really is very customer specific, which is why it takes time. It is not as if we go out and raise prices X percent to all of our customers overnight. It is definitely a conversation with in essence each and everyone of our customers..

This is Jeff. But in reference to all of our salespeople, they do a wonderful job. The idea of getting the price increase never is easy. It's just not inaccurate, but we are absolutely a profit driven business, not a revenue driven business or at least revenue growth driven business, despite the fact that we could have pretty good revenue growth.

And ultimately we're going to get paid for our services. We think we do a great job. Frankly I almost think [indiscernible] almost, I do believe we should get paid more. Frankly independent of even the material price increases for what we do for our customers pride ourselves on service.

So is it perfectly linear and is exactly kind of perfect sequence, it is not. I've said that before, but ultimately, over time, through the course of quarter or so after price increase is announced we end up being able to push the price increases..

Our next question comes from Michael Eisen with RBC..

Just wanted to start of continuing the conversation about around same branch single-family incremental margin performance.

Is there anyway you can help us better desegregate that from the Alpha investment? And kind of think of what it was in the true legacy business? And just because it sounds like you're hitting the marks you've talked to, but I just wanted to confirm that that's the case?.

Yes, as we said in the prepared remarks, it's the performance that we saw kind of excluding Alpha on the same-branch incremental basis. It's what gives us confidence around stating or restating, I should say that full year 20% to 25% in incremental margin.

So again, the third and fourth quarter typically are our most profitable quarters on a historical basis. We expect that to be the case this year as well, but what we saw in the second quarter and the momentum that we saw in the business on the residential side gives us a lot of confidence, quite frankly, for the rest of the year..

Got it, that's helpful. And then following up on the commercial side of the business.

Is there slight slowdown in the quarter from what you saw in growth last quarter? Is there anything we should think about what's going on there as you're doing these expansion initiatives that would cause growth to not be your strongest end markets? Or is there potential for higher levels of growth as you move forward?.

Yes, it's really more question of large projects rolling off and the commercial business unlike the residential business, so there's a little bit lumpy on that respect quarter-to-quarter. So as we mentioned in the prepared remarks, the Alpha business has grown 20% plus since we've acquired it.

The growth has come from opening up these other branches, which we've had to make an investment in. But we feel very good long-term about the strategy that we're executing there as a team that's there and the way that they're performing..

Understood.

And if I can sneak one more and I think on the last call, you had talked about certain end markets there's now some over index to other installers where you guys maybe able to get some share off the bat? Is there -- is some that fueling the strong growth in your same-branch business? Or is that something that still hasn't come through given the back half weighted jobs coming in?.

I would say it's not driving it as Jeff pointed out, I mean, we're not a volume driven company, we're profit driven company. So while in certain instances, where there might be opportunities for us, we're only going after those opportunities if they are at a margin and at a price that is acceptable to us.

So we're not going to -- we never want to chase share..

This is Jeff again. But this time, I'm going to respond in reference to our production managers and those that are also in charge of hiring installers for us. And what I can say is that they're doing a great job and this is going to sound a little bit remarkable, but we probably feel better about our labor position right now than we have in some time.

And we are seeing some of the fruits from some of the efforts we put into trying to slow down our turnover and really made a talk on a number of calls on number of quarters.

And I think at least partly to the extent that you have labor and to the extent that you cannot have to spend that the amount of time and effort that we have in the past although, we continue to do that. You create capacity within the organization and there's plenty of work out there.

So the extent that we have the labor and we feel good about it, we're able to take on the job now. Obviously, this is what helps drive sales growth..

And our next question comes from Susan Maklari with Crédit Suisse..

The first thing I want to touch on is the SG&A. It seems like you made some really good progress this quarter there.

Can you just talk a little bit about what drove that? And maybe how we should think about it going forward? How sustainable is that?.

Yes, that's a good question.

We did make good progress on it and we're really been made good progress on the kind of SG&A leverage over the past several quarters and as we have talked, I think, on numerous quarters as we get back to that sort of mid-teens EBITDA margin, we believe that we're going to get some of that benefit from SG&A leverage and we'll get some of that benefit from improving gross margin, particularly as we get out of the current environment that we're in from an inflationary perspective.

We obviously don't have full insight into '19 yet but we don't expect the environment in '19 to be as similar it is in '18, in terms of the number of price increases and rigidity associated with them.

Obviously, that's yet to be seen, but -- and it will obviously depend upon demand in the marketplace [indiscernible] and all kind of stuff but ultimately, from experience, we know that rising material price environment once it's fully digested by us and our customers ends up being a margin improvement event for us..

Got you, okay. And then in terms of the M&A pipeline, I know that in your remarks you just said that it obviously remains fairly robust.

Can you just give us some more color though on what you're seeing in sort of the traditional installation side of things versus some of the newer markets that you're getting into, be it in the blinds and things like that? Or even on the commercial side if there's anything that's coming up out there?.

Susan, it's Jeff. So clearly, we continue to focus on doing an industry kind of vanilla insulation deals. Obviously, though we, as part of our strategy, expanded the universe of products that we're looking at.

What's a little unique about the other the product categories versus insulation is that the idea of acquisitions in insulation has been around honestly for decades. I mean and -- so that, which is what really drove our originally our stance in terms of resource deals, I mean, we really had to work to find these deals.

What's different about the other product categories is historically, I don't think they really had that same kind of unhesitant use of road-rollup because I don't believe that. I don't believe that is what we're doing. Some people can argue with me about it.

But when you do this for 22 years or 24 years, it doesn't feel to me like a rollup per se, it's just one of our strategies to grow the business. But in these other categories, they haven't had kind of a lot of acquirers. So as a result, many of these deals are finding their way to our doorsteps.

So I would say, that's the bigger differential and you can see, I think, typically a lot of it comes from our announcements that because of that and a lot of cases we were able to buy them maybe more effectively.

And so that, in our mind, kind of helps justify this also and we would argue typically, we would want to buy these at a little more attractive kind of pricing and economics.

Just because, in most cases, this is not the absolute kind of easy drop to the bottom line material advantage that we talked to and it's not, but it's not what it is necessarily of insulation. So probably doesn't support [indiscernible]..

The next question comes from Phil Ng with Jefferies..

Some of the prominent builders have talked about initially some slowdown due to tight labor conditions.

Curious if you are seeing any of that? And do you do see growth decelerating to back half, certainly your prepared remarks do not suggest that, but just curious to get your thoughts?.

Yes, it's just that just a minute ago, we feel probably better about labor now than we've had in a long time. And part of it is initiatives that we have been undertaking to invest in the people and the great execution of our local teams in terms of trying to do a very effective job of managing labor force.

So we are not the pinch point for our builders from a labor perspective. I do think that certainly, there's a lot of negative sentiments or changing sentiment I should say that's been in the news recently around housing.

Our opinion is that and based on kind of feedback from our customers and from what we see that, that it is a little overblown and quite frankly, the market particularly when you talk about very high housing markets where people have talked about declines in prices and increase in inventory, all of that is a positive in our opinion.

Because those markets were -- some of those markets like Seattle, for example, were really at a nonsustainable spot. So they're now coming to a more rational, we think appropriate level.

And I think if you look at the order growth from the builders that have reported so far, really the builders that are doing entry level product and affordable product are seeing outsized order growth, which is consistent with the way that we would've expected the market to continue to recover.

I think we have all talked about this and seen this that to get to a stabilized $1 million, $4 million price housing starts, you need to have the balance between multifamily, single-family and single-family starter homes or new entry homes and [indiscernible] homes and higher end move-up homes.

And I think what you're seeing is that shift in the market is happening now. Maybe a little bit faster than what people expected. But we think that, that portends for a very healthy housing environment and a very healthy backdrop.

One of the things that we look closely and I'm sorry for maybe going too long to answer your question, but one of the things that we look closely at because we think is even a better indicator than [indiscernible] is the [indiscernible] acquisition and development loan growth at banks.

And that's been in the low double-digits for the past couple of quarters and that is we believe is a very strong indicator of land development and the availability of that capital is very, very strong. So we feel very good about the long-term -- medium to long-term ability of the housing market to get back to stabilize $1.5 million.

It's never going to just a straight line up, but we would not take one month of data and over interpret that to mean that there's a slowdown coming in the housing market..

Got it, that's really helpful perspective. Good to see you're making positive momentum on the pricing front. But certainly as you kind of highlight in the call, the insulation manufactures have series of increases out there as well.

Just wanted to get your thoughts when you think about price cost in general, is the expectation of that spread continue to make positive progress in the back half versus the front half?.

That's our objective..

Okay, that's helpful. And just one last one.

As you kind of expand your commercial business, how are you kind of balancing the point capital via organic investments growing of these branches or approaching it through M&A?.

That's a great question. Because the answer is different on the commercial side than it is on the residential side. So because on the residential side, we very rarely deploy capital to organically grow locations. Obviously, we're growing organically within our existing locations. The commercial side is different.

So on the commercial side, we -- there's a slight preference to expand organically, make these investments versus acquisitions. But at the same time, we are very interested in doing product extension acquisitions in the commercial space.

So that we get more capabilities and become more relevant and stick here, if you will, with the GCs that we're are working with..

Our next question comes from Keith Hughes with SunTrust..

So there's some announcements of another insulation increase in the third quarter just kind of get your views on that and is that going to cause continued drag on the margins on a insulation-specific basis in the third quarter?.

As we said, I think, earlier in the call, I mean, ultimately, a rising price environment is supportive of the business. It does take time to work those price increases into the system, especially when you had three fairly firm price increases in a year, which is I don't think has ever happened.

So definitely, it is something that we are very focused on and working very hard with our sales people, our branch managers and our customers. Ultimately, as we've said, I think, a couple of times in the call, we're not volume based or volume focused, we're profit focused. And we would definitely sacrifice volume for gross..

Keith, there's obviously other pressures on cost, whether it's labor, I mean, that's well documented. I mean, cost in the industry really almost crossed the entire economy? So I mean it's imperative that we get these price increases.

We know that and frankly we deserve it like I said earlier, it's just -- it is kind of it is a saw -- as I say kind of like teeth on a saw. So there'll be a little bit kind of grinding at August but ultimately, we'll get on top of it..

Okay. And your comment on Alpha on the startup cost, now. I understand Alpha, it takes a lot to get these branches going.

So I understand how this revenue offsets could come, pretty notably in '19? But it seems like you'll hardly get this in the second half of the year? And you spoke to this earlier but it seems like there will still be a fair amount of offset in the second half or is there something unusual going on?.

Yes, you are right, Keith, I mean, and I may have misspoke a little bit, but we're looking at kind of stabilize, if you will, in '19.

I guess what, my comment was meant to more say is that the headwinds we saw in the second quarter we just don't expect -- what we expected to be a headwind, we don't expect it to be as much of a headwind in the second half, I guess..

One could argue that we've opened six locations since the alpha acquisition, technically it's probably four because two were opened just prior to our closing with Alpha. But in terms of cost and then not be going to be able to carry themselves, I'm going to use six.

So that's kind of the weight of what it is that we have endeavored to do and again believe it is smart thing to do. What I can also say is always we 100% understand that you can't call a branch a new branch forever and hide behind that.

So they have to make money, they have to make money in a time frame that we are new is a reasonable term, right? We can't revisit something three years out and say what's in new branch, you get it, they got to make money, but it does take a period of time like Michael alluded to, something that I think is pretty reasonable probably in terms of time frame..

And just finally, this issue you just discussed that is the majority of the 120 basis point gross margin decline in the quarter?.

It is the largest portion of it, yes..

The next question comes from Justin Speer With Zelman and Associates..

In terms of the branches just following up on that.

How many branches, I guess, maybe like the cadence, how many branches did you open in the quarter? And in terms of seasoning just thinking about the cadence, are they running like half rate or are they running 2/3 of what your ideal kind of mature Alpha branch is running? Just kind of give us some context of the timing here..

Really depends on the location, yes. And I'd like to say that it's moved trend upwards but it's not. Because there particularly when they're small and they're starting out and the volume of the project and the lead time associated with them, they're really just lumpy.

So it's really about getting scale on those location, which we think we will be at that place in '19, getting scale on those locations to get them to the right level of profitability.

So there's a -- and the reason that we're not giving any specific dollar amounts or margins is because there's a high rate of variability among those different locations. But their profitability is definitely not consistent with what we expect from the other Alpha locations..

But did they come on in the first half? Or these new locations from legacy investment back in like '17?.

Yes, so some of them came on last year and some of them came on this year.

It is the gestation period if you will, but one of these branches is much longer than it would be for, it's not 100% accurate, but it's much longer than it would be for residential branch because of the timing of when you bid a job, when you actually start to work on the job, how long it takes to recognize revenue over the course of that job.

If we were going to go de novo on a residential branch, we could fit work today and do it Monday, right? So they would bid work today and might not do it for six months or a year..

Well it can't start, if we do an organic residential location. We have already got the book of business and in lot of cases we have been asked to go there..

Exactly. Yes, just it's really quite different in that perspective. And it just again given the size and the length of their projects decrease and some lumpiness, but we definitely think having a broader network serving the regional and national customers in that business makes a lot of time..

So in terms of the intermediate term -- the target that you're setting particularly on the margin side and thinking about the, I guess, the investment requirements to get to that revenue cadence that you ideally going to look for in the commercial business anyway.

Thinking about the future, do you think you'll need or you'll see more investments in new branches or do you think you have what -- you're going to go to work with what you have and that will get you to where you need to in the intermediate term roadmap?.

This is Jeff. I think half a dozen locations in the period of time we're talking about it was pretty aggressive. Again, we supported it and believe it was the right move.

I think we'll spend a little bit of time here probably not looking to expand actual physical locations and instead, get the 4 to 6 branches we just discussed whether it need to be from a profitability and more stabilized..

And then switching gears one last question for me, with the recent large competitor consolidation just would like to get your some context or observations from you -- in terms of the competitive landscape if it's changed, if it led to the opportunities to shaking your way potentially from that outcome..

I would say the completive environment really has not changed much at all. I mean, as we said kind of earlier in the call we are focused on profitable business and are not going to just chase volume.

So we're making sure that any opportunities that come our way in any markets is really at a margin particularly in this kind of environment is that a margin that we think is acceptable..

And I guess one follow up just in terms of that 20% to 25% same-store incremental, I guess, and that's including Alpha.

I'm assuming you're including the commercial investment that you're making you think for the full year the same-store business can do a 20% to 25% still find kind of a upper 20s back half incremental margin on a same-store basis?.

Yes, I think when I said that we do not provide guidance and that feels like a lot like guidance. So but I did -- we would say that there will probably be still headwinds as we said earlier in the call in the second half the kind of Alpha investment, if you will, just not as heavy it was in the second quarter.

So we still feel very good, particularly when we look at just the residential business that 20% to 25% number makes a lot of sense..

The next question comes from Matt McCall with Seaport Global..

I think that somebody asked a question, I didn't hear the answer.

Did you quantify what investment in Alpha was that you're talking about just in Q2?.

We did not dollar quantify it, but we indicated that the gross margin compression that we felt was primarily attributable to this investment in Alpha..

Okay. And I think you just said, Michael, that the -- you talked about opening the branches, I think, over the last 12 months.

Was there something that changed about the spending pattern in Q2 relative to what you're seeing? Did you have similar spending in Q1? I'm just trying to understand the comment about the new branches you've opened up and then the fact that you're highlighting more of the spending just around Q2..

It was just exacerbated a little bit more in Q2, just given the timing and nature of projects, particularly as we talked about earlier the slower sales growth in Alpha, right? It's highlighted more because the other -- because of the fall of some other projects in some of the other core Alpha branches..

Okay. All right.

So there was some pressure in Q1, just not as -- maybe as much as what you just experienced?.

Yes. And I would say that the core branches kind of overperformed to help compensate for some of that weakness..

Okay, got it. Then one on price/mix. So I'm trying to put all of the components together. So the pricing is up, there is another price increase in this month from the manufacturers. You've got some mix pluses, you talked about the other category growth as a mix minus.

Can you talk about the kind of the price versus mix in that 5.5%, and then I know you talked about price cost expectations improving. But what about price/mix in the back half? I think your comp gets a little bit tougher versus your space? I'm just trying to understand what the expectations are for price/mix specifically in the back half..

Well, as you know, we don't provide guidance, but we feel comfortable that the price/mix trends that we're seeing now are good.

And while we do expect to continue to see good growth in the other products, and perhaps, at a rate higher than the insulation sales growth, but we feel confident that we're going to continue to have good price/mix growth through the entire year -- to back half of the year..

So what I have to assume -- I'm assuming -- I would have to assume some improved price/mix relative to that 5.5% to get to the price cost or the margin improvement that you're expecting?.

Well, keep in mind that the third quarter and fourth quarter are typically our most profitable quarters, because we typically have higher volume in those quarters, which then in itself helps improve both SG&A leverage as well as gross margin improvement.

And the efforts that we're making to improve our selling prices to our customers and I should note that's not just on the insulation side, it's really on all of our products. Trying to get that price improvement, we believe, will lead to a situation where the second half is more profitable than the first half as is, historically, the case..

The next question comes from Ken Zener with KeyBanc..

This is [indiscernible] here. So the incremental margin. Would I see -- Mike, I understand you're not giving guidance. People are trying to understand these two businesses. To me, what I hear you saying is when you're opening up commercial branches, they cost money.

You've kind of been missing in that $2 million to $3 million in the normal incremental on the organic, so 20% to 25% came in at 12%. $3 million divided by 4 branches. It seems like when you open up branches, they kind of having just over $1 million drag to your normal incremental margins that you would expect to all else equal.

So to that extent realizing you don't give margins, people just want to understand that drag.

So if you've opened up for the six just that you just mentioned, can you give us just an idea of how many new branches you might plan on opening over the next two years? Because if we have that number, we can just kind of create a forecast for the drag to the 20% to 25% incremental, you say that you're getting in your business and, I think, that would help clarify the confusion around your good execution which is not being as clean in your reported results..

That's a good question, Cannon And as Jeff said earlier, really our objective with the Alpha locations is to get what we have now and what we roped in stabilized and back to the level that we expect from this business from a profitability perspective.

We may open 1 or 2 more locations, but it's not going to be the same kind of investment we've made here recently.

So -- which is why, in our prepared remarks, we talked about '19 being the year where we don't see any of the headwinds associated with this because we see a pathway towards being at a rate that we would expect from a profitability perspective from those additional locations. So -- yes, it's a good question, but....

We'll go much slower. You did a good job of being....

Okay. Yes, I think that's it. I mean, I think people -- branches how many, you can calculate the dollar drag per branch. But I think the discussion can move on, which I think behooves the conservation. My next question, Michael, you talked about orders from -- more from the entry level or activity more at the entry level.

Could you just talk about the dollar, the size of the market? I think, you guys have talked about $2.5 billion or so.

What that would imply in terms of -- on the insulation side? What that means for incremental installation dollars, if it has to be at the lower price point as opposed to the higher price point? If that itself would have any change in the trend line that you've seen in recent years?.

Yes, I think, the -- what it changes is the value put in place, right? Because instead of a $500,000 star home, it's a $200,000 star home. But I think, the key is just ultimately that higher volume is what we're after, right? We're very happy insulating 10 more $200,000 houses versus one $500,000 house.

So I think, the ultimate volume continues to grow. And fundamentally, for the economy, we believe that we need this balance to happen. I mean we want housing to be affordable for millennials coming in that have expressed a high desire for homeownership. So we think it's a question of the market rebalancing to healthy levels.

So again -- I mean, it is definitely a shift and it takes time. It doesn't happen overnight. But we think it's a positive shift ultimately for the health of the housing industry..

So this does conclude our question-and-answer session. And I would like to turn the conference back over to Jeff Edwards for any closing remarks..

I'd just like to thank all of you for your questions. And I look forward to our next quarterly call. Thank you..

Thank you..

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day..