TOPBUILD CORP. The financial and business analysis below provides information which we believe is relevant to an assessment and understanding of our financial position, results of operations, and cash flows. This financial and business analysis should be read in conjunction with the financial statements and related notes. In this section, we generally discuss the results of our operations for the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 . For a discussion of the year endedDecember 31, 2018 to the year endedDecember 31, 2017 , please refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year endedDecember 31, 2018 , filed with theSEC onFebruary 26, 2019 , which discussion is hereby incorporated herein by reference. Executive Summary
We are a leading installer and distributor of insulation and other building products to theU.S. construction industry. Demand for our products and services is driven primarily by residential new construction, commercial construction, and residential repair/remodel activity throughout theU.S. A number of local and national factors influence activity in each of our lines of business, including demographic trends, interest rates, employment levels, business investment, supply and demand for housing stock, availability of credit, foreclosure rates, consumer confidence, and general economic conditions.
Activity in the construction industry is seasonal, typically peaking in the summer months. Because installation of insulation historically lags housing starts by several months, we generally see a corresponding benefit in our operating results during the third and fourth quarters.
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Strategy
Our long-term strategy is to grow net sales, net income, and operating cash flows and remain the leading insulation installer and distributor by revenue.
In order to achieve these goals, we plan to:
? Capitalize on the
accretive aligned acquisitions
? Gain share in commercial construction
Continue to leverage our expertise in building science through our Environments
? for Living® program to benefit from the increasing focus on energy efficiency
and trends in building codes
? Grow our business through acquisitions of complementary businesses
Our operating results depend heavily on residential new construction activity and, to a lesser extent, on commercial construction and residential repair/remodel activity, all of which are cyclical. We are also dependent on third-party suppliers and manufacturers providing us with an adequate supply of high-quality products.
Material Trends in Our Business
Housing starts (as reported by theU.S. Census Bureau ) were lower than prior year in the first half of 2019. However, in the 3rd quarter housing starts outpaced prior year by 3.9% and in the fourth quarter housing starts were 19.6% higher than prior year. This positive uptick in starts, combined with the current low interest rate environment, is driving optimism for the housing market for the year 2020. We expect this industry tailwind in new residential construction to be slightly tempered by a lower revenue per housing unit. This lower revenue per unit is being driven by higher multifamily starts vs. single-family starts, and by the shift by homebuilders toward smaller, more affordable, single-family units. In 2019, we experienced strong growth vs. prior year in our sales to commercial construction markets. We expect these markets, both light and heavy commercial, to remain strong in near-term with revenue in heavy commercial uneven due to timing and the nature of these larger construction projects. Seasonality
We normally experience stronger sales during the third and fourth calendar
quarters, corresponding with the peak season for residential new construction
and residential repair/remodel activity. Sales during the winter weather months
are typically slower due to lower construction activity. Historically, the
installation of insulation lags housing starts by several months.
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Results of Operations
We report our financial results in conformity with GAAP.
The following table sets forth our net sales, gross profit, operating profit,
and margins, as reported in our Consolidated Statements of Operations, in
thousands:
Year Ended December 31,
2019 2018
Net sales $ 2,624,121 $ 2,384,249
Cost of sales 1,942,854 1,808,097
Cost of sales ratio 74.0 % 75.8 %
Gross profit 681,267 576,152
Gross profit margin 26.0 % 24.2 %
Selling, general, and administrative expense 391,744 367,199
Selling, general, and administrative expense to sales ratio 14.9 % 15.4 %
Operating profit 289,523 208,953
Operating profit margin 11.0 % 8.8 %
Other expense, net (35,745) (28,129)
Income tax expense (62,783) (46,072)
Effective tax rate 24.7 % 25.5 %
Net income $ 190,995 $ 134,752
Net margin 7.3 % 5.7 %
Comparison of the Years Ended
Sales and Operations
Net sales for 2019 increased 10.1 percent, or
The increase was primarily driven by our USI acquisition in
Our gross profit margin was 26.0 percent and 24.2 percent for 2019 and 2018, respectively. Gross profit margin improved primarily due to increased selling prices, higher sales growth in our Installation segment vs. Distribution segment, operational efficiencies, and synergies from the USI acquisition, partially offset by higher material costs. Selling, general, and administrative expense as a percentage of sales was 14.9 percent and 15.4 percent for 2019 and 2018, respectively. Decreased selling, general, and administrative expense as a percent of sales was primarily the result of lower acquisition and closure costs related to the USI acquisition. Operating margins were 11.0 percent and 8.8 percent for 2019 and 2018, respectively. The increase in operating margins related to increased selling prices, increased sales volume, operational efficiencies, synergies from the USI acquisition, and lower acquisition and closure costs related to the USI acquisition, partially offset by higher material costs. Other Expense, Net Other expense, net, which primarily consists of interest expenses, increased$7.6 million to$35.7 million in 2019 compared with 2018. The increase is primarily related to the issuance of our$400 million Senior Notes and our borrowing of the$100 million delayed draw term loan to fund our acquisition of USI in the second quarter of 2018, as well as the issuance of$15.0 million
of
equipment notes in 2019.
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Income Tax Expense
Our effective tax rate decreased from 25.5 percent in 2018 to 24.7 percent in 2019. The lower 2019 rate was primarily related to an increased benefit from share-based compensation partially offset by an increase in the state and local taxes. The state and local tax increase was due to a revaluation of deferred tax assets & liabilities resulting from state filing position changes, with some offsetting benefit for the state return to provision adjustment and other miscellaneous state adjustments.
2019 and 2018 Business Segment Results
The following table sets forth our net sales and operating profit information by business segment, in thousands:
Year Ended December 31,
2019 2018 Percent Change
Net sales by business segment:
Installation $ 1,906,730 $ 1,680,967 13.4 %
Distribution 862,143 820,309 5.1 %
Intercompany eliminations (144,752) (117,027)
Net sales $ 2,624,121 $ 2,384,249 10.1 %
Operating profit by business segment (a):
Installation $ 253,230 $ 196,986 28.6 %
Distribution 90,388 78,739 14.8 %
Intercompany eliminations (23,921) (20,899)
Operating profit before general corporate
expense 319,697 254,826 25.5 %
General corporate expense, net (b) (30,174) (45,873)
Operating profit $ 289,523 $ 208,953 38.6 %
Operating profit margins:
Installation 13.3 % 11.7 %
Distribution 10.5 % 9.6 %
Operating profit margin before general
corporate expense 12.2 % 10.7 %
Operating profit margin 11.0 % 8.8 %
Segment operating profit for years ended
segments which is based on direct benefit or usage (such as salaries of
corporate employees who directly support the segment).
General corporate expense, net includes expenses not specificallyattributable to our segments for functions such as corporate human resources, (b) finance and legal, including salaries, benefits, and other related costs. In
the years ended
decreased primarily due to merger and acquisition costs incurred related to
the USI acquisition in 2018.
2019 and 2018 Business Segment Results Discussion
Changes in operating profit margins in the following business segment results discussion exclude general corporate expense, net in 2019 and 2018, as applicable.
Installation Sales
Sales increased
Sales increased 7.1 percent from acquisitions, 3.8 percent due to increased selling prices, and 2.5 percent due to increased sales volume, primarily in
our
commercial markets.
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Operating Results
Operating margins in the Installation segment were 13.3 percent and 11.7 percent
for 2019 and 2018, respectively. The increase in operating margins related to
increased selling prices, increased sales volume, operational efficiencies, and
synergies from the USI acquisition, partially offset by higher material costs.
Distribution
Sales
Sales increased $41.8 million , or 5.1 percent, in 2019 compared to 2018. Sales
increased 4.6 percent due to increased selling prices, 1.3 percent from
acquisitions, and decreased 0.8 percent due to volume. Volume decreased
primarily due to deliberate decisions with respect to price and volume, as well
as the decision to exit some low margin business.
Operating Results
Operating margins in the Distribution segment were 10.5 percent and 9.6 percent
for 2019 and 2018, respectively. The increase in operating margins related to
increased selling prices and operational efficiencies, which were partially
offset by increased material costs.
Commitments and Contingencies
Litigation
We are subject to certain claims, charges, litigation, and other proceedings in
the ordinary course of our business, including those arising from or related to
contractual matters, intellectual property, personal injury, environmental
matters, product liability, product recalls, construction defects, insurance
coverage, personnel and employment disputes, antitrust, and other matters,
including class actions. We believe we have adequate defenses in these matters,
and we do not believe that the ultimate outcome of these matters will have a
material adverse effect on us. However, there is no assurance that we will
prevail in any of these pending matters, and we could in the future incur
judgments, enter into settlements of claims, or revise our expectations
regarding the outcome of these matters, which could materially impact our
liquidity and our results of operations.
Other Commitments
We enter into contracts which include customary indemnities that are standard
for the industries in which we operate. Such indemnities include, among other
things, customer claims against builders for issues relating to our products and
workmanship. In conjunction with divestitures and other transactions, we
occasionally provide customary indemnities relating to various items including,
among others: the enforceability of trademarks; legal and environmental issues;
and asset valuations. We evaluate the probability that we may incur liabilities
under these customary indemnities and appropriately record an estimated
liability when deemed probable.
We also maintain indemnification agreements with our directors and officers that
may require us to indemnify them against liabilities that arise by reason of
their status or service as directors or officers, except as prohibited by
applicable law.
We occasionally use performance bonds to ensure completion of our work on certain larger customer contracts that can span multiple accounting periods.
Performance bonds generally do not have stated expiration dates; rather, we are
released from the bonds as the contractual performance is completed. We also
have bonds outstanding for license and insurance. For additional information
see Item 8. Financial Statements and Supplementary Data - Note 11. Other
Commitments and Contingencies.
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Liquidity and Capital Resources
We have access to liquidity through our cash from operations and available borrowing capacity under our Amended Credit Agreement, which provides for borrowing and/or standby letter of credit issuances of up to$250 million under the Revolving Facility. For additional information regarding our outstanding debt and borrowing capacity see Item 8. Financial Statements and Supplementary Data - Note 6. Long-Term Debt. We believe that our cash flows from operations, combined with our current cash levels and available borrowing capacity, will be adequate to support our ongoing operations and to fund our debt service requirements, capital expenditures, and working capital for at least the next twelve months. Cash flows are seasonally stronger in the third and fourth quarters as a result of increased new construction activity during those periods.
The following table summarizes our total liquidity, in thousands:
As of December 31,
2019 2018
Cash and cash equivalents (a) $ 184,807 $ 100,929
Revolving Facility 250,000 250,000
Less: standby letters of credit (61,382) (59,288)
Availability under Revolving Facility 188,618 190,712
Total liquidity$ 373,425 $ 291,641
(a) Our cash and cash equivalents consist of AAA-rated money market funds as well
as cash held in our demand deposit accounts.
Cash Flows
The following table presents a summary of our cash flows provided by (used in)
operating, investing and financing activities for the periods indicated, in
thousands:
Year Ended December 31,
2019 2018
Changes in cash and cash equivalents:
Net cash provided by operating activities $ 271,777 $ 167,172
Net cash used in investing activities (50,142)
(551,819)
Net cash (used in) provided by financing activities (137,757) 429,055 Increase (decrease) for the period
$ 83,878 $ 44,408 Net cash flows provided by operating activities increased$104.6 million for the year endedDecember 31, 2019 , as compared toDecember 31, 2018 . The increase was primarily due to an increase in net income, the timing of working capital collections and expenditures, and the timing of income tax payments. Net cash used in investing activities was$50.1 million for the year endedDecember 31, 2019 , primarily comprised of$45.5 million for purchases of property and equipment, primarily vehicles, and$7.0 million for acquisitions, and partially offset by$2.3 million of proceeds from the sale of property and equipment. Net cash used in investing activities was$551.8 million for the year endedDecember 31, 2018 , primarily comprised of$500.2 million of net cash for the acquisition of USI and ADO and substantially all of the assets ofSanta Rosa , and$52.5 million for purchases of property and equipment primarily vehicles, partially offset by$0.8 million of proceeds from the sale of property and equipment. 27 Table of Contents
Net cash used in financing activities was$137.8 million for the year endedDecember 31, 2019 . We used$110.9 million for common stock repurchases related to our share repurchase programs, including$50.0 million under the 2019 ASR Agreement,$21.9 million for payments on our term loan,$13.0 million for purchases of common stock for tax withholding obligations related to the vesting and exercise of share-based incentive awards,$5.9 million for payments on our equipment financing notes, and$1.1 million for payments of contingent consideration for EcoFoam andSanta Rosa . We received$15.0 million of proceeds from equipment financing notes. Net cash provided by financing activities was$429.1 million for the year endedDecember 31, 2018 . In 2018, we received$400.0 million from the issuance of our Senior Notes and$100.0 million from the delayed draw on our term loan which we used to fund our acquisition of USI. We received$26.6 million of proceeds from equipment financing notes related to our decision to begin purchasing rather than leasing vehicles. We used$65.0 million for common stock repurchases related to our share repurchase programs, including$50.0 million under the 2018 ASR Agreement,$16.3 million for payments on our term loan,$7.8 million for payment of debt issuance costs related to our Amended Credit Agreement and our Senior Notes,$5.5 million for purchases of common stock for tax withholding obligations related to the vesting and exercise of share-based incentive awards, and$2.1 million for payments on our equipment financing notes. We also made a payment of$0.8 million of contingent consideration for EcoFoam. We drew$90.0 million on our Revolving Facility
and repaid$90.0 million
Critical Accounting Policies and Estimates
We prepare our Consolidated Financial Statements in conformity with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities, at the date of the financial statements, and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates. Our significant accounting policies are more fully described in Item 8. Financial Statements and Supplementary Data - Note 1. Summary of Significant Accounting Policies. However, certain of our accounting policies considered critical are those we believe are both most important to the portrayal of our financial condition and operating results and require our most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Judgments and uncertainties affecting the application of those policies may result in materially different amounts being reported under different conditions or using different assumptions. We consider the following policies to be most critical in understanding the judgments that are involved in preparing our Consolidated Financial Statements.
Revenue Recognition and Receivables
We recognize revenue for our Installation segment over time as the related
performance obligation is satisfied with respect to each particular order within
a given customer's contract. Progress toward complete satisfaction of the
performance obligation is measured using a cost-to-cost measure of progress
method. The cost input is based on the amount of material installed at that
customer's location and the associated labor costs, as compared to the total
expected cost for the particular order. Revenue is recognized as the customer
is able to receive and utilize the benefits provided by our services. Each
contract contains one or more individual orders, which are based on services
delivered. When a contract modification is made, typically the remaining goods
or services are considered distinct and we recognize revenue for the
modification as a separate performance obligation. When material and
installation services are bundled in a contract, we combine these items into one
performance obligation as the overall promise is to transfer the combined item.
Revenue from our Distribution segment is recognized when title to products and
risk of loss transfers to our customers. This represents the point in time when
the customer is able to direct the use of and obtain substantially all the
benefits from the product. The determination of when control is deemed
transferred depends on the shipping terms that are agreed upon in the contract.
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At time of sale, we record estimated reductions to revenue for customer programs
and incentive offerings, including special pricing and other volume-based
incentives based on historical experience, which is continuously adjusted. The
duration of our contracts with customers is relatively short, generally less
than a 90-day period, and therefore there is not a significant financing
component when considering the determination of the transaction price which gets
allocated to the individual performance obligations, generally based on
standalone selling prices. Additionally, we consider shipping costs charged to a
customer as a fulfillment cost rather than a promised service and expense as
incurred. Sales taxes, when incurred, are recorded as a liability and excluded
from revenue on a net basis.
We record a contract asset when we have satisfied our performance obligation
prior to billing and a contract liability when a customer payment is received
prior to the satisfaction of our performance obligation. The difference between
the beginning and ending balances of our contract assets and liabilities
primarily results from the timing of our performance and the customer's payment.
We maintain allowances for doubtful accounts receivable for estimated losses
resulting from the inability of customers to make required payments. In
addition, we monitor our customer receivable balances and the credit worthiness
of our customers on an on-going basis. During downturns in our markets,
declines in the financial condition and creditworthiness of customers impact the
credit risk of the receivables involved and we have incurred additional bad debt
expense related to customer defaults.
We have two reporting units, which are also our operating and reporting segments: Installation and Distribution. Both reporting units contain goodwill. Assets acquired and liabilities assumed are assigned to the applicable reporting unit based on whether the acquired assets and liabilities relate to the operations of and determination of the fair value of such unit.Goodwill assigned to the reporting unit is the excess of the fair value of the acquired business over the fair value of the individual assets acquired and liabilities assumed for the reporting unit. We perform our annual impairment testing of goodwill in the fourth quarter of each year, or as events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. When assessing goodwill for impairment, we have the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, we determine it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then we perform a two-step impairment test. If we conclude otherwise, then no further action is taken. We also have the option to bypass the qualitative assessment and only perform a quantitative assessment, which is the first step of the two-step impairment test. In completing the two-step impairment test, we complete the impairment testing utilizing a discounted cash flow method. We selected this methodology because we believe that it is comparable to what would be used by other market participants. Our operating segments are reporting units that engage in business activities for which discrete financial information, including long range forecasts, is available. We have identified our segments as our reporting units and complete the impairment testing of goodwill at the operating segment level, as defined by accounting guidance. Fair value for our reporting units is determined using a discounted cash flow method which includes significant unobservable inputs (Level 3 inputs). Determining market values using a discounted cash flow method requires us to make significant estimates and assumptions, including long term projections of cash flows, market conditions, and appropriate discount rates. Our judgments are based on historical experience, current market trends, consultations with external valuation specialists, and other information. While we believe that the estimates and assumptions underlying the valuation methodology are reasonable, changes to estimates and assumptions could result in different outcomes. In estimating future cash flows, we rely on internally generated long range forecasts for sales and operating profits, and generally a one to three percent long term assumed annual growth rate of cash flows for periods after the long range forecast. We generally develop these forecasts based upon, among other things, recent sales data for existing products, and estimatedU.S. housing starts. 29 Table of Contents When necessary, an impairment loss is recognized to the extent that a reporting unit's recorded goodwill exceeds its implied fair value. We did not recognize any impairment charges for goodwill for the years endedDecember 31, 2019 , 2018, and 2017. As ofDecember 31, 2019 , net goodwill reflected$762.0 million of accumulated impairment losses, relating primarily to impairment charges taken in 2008-2010 following the substantial decrease inU.S. housing starts after the financial crisis of 2007-2008. In the fourth quarter of 2019, we performed an assessment on our goodwill and determined that the estimated fair value of each reporting unit substantially exceeded its carrying value atDecember 31, 2019 , and therefore the goodwill was not impaired. In the fourth quarter of 2018, we performed an assessment on our goodwill and concluded that it was more-likely-than-not that goodwill was not impaired. Intangible assets with finite useful lives are amortized using the straight-line method over their estimated useful lives. We evaluate the remaining useful lives of amortizable identifiable intangible assets at each reporting period to determine whether events and circumstances warrant a revision to the remaining periods of amortization. Income Taxes If, based upon all available evidence, both positive and negative, it is more likely than not (more than 50 percent likely) such deferred tax assets will not be realized, a valuation allowance is recorded. Significant weight is given to positive and negative evidence that is objectively verifiable. A company's three year cumulative loss position is significant negative evidence in considering whether deferred tax assets are realizable and the accounting guidance restricts the amount of reliance we can place on projected taxable income to support the recovery of deferred tax assets. Current accounting guidance allows the recognition of only those income tax positions that have a greater than 50 percent likelihood of being sustained upon examination by taxing authorities. We believe that there is an increased potential for volatility in our effective tax rate because this threshold allows changes in the income tax environment and the inherent complexities of income tax law in a substantial number of jurisdictions to affect the computation of the liability for uncertain tax positions to a greater extent. While we believe we have adequately assessed for our uncertain tax positions, amounts asserted by taxing authorities could vary from our assessment of uncertain tax positions. Accordingly, provisions for tax-related matters, including interest and penalties, could be recorded in income tax expense in the period revised assessments are made. Business Combinations
The purchase price for business combinations is allocated to the estimated fair values of acquired tangible and intangible assets, including goodwill, and assumed liabilities, where applicable. Management uses significant judgments involving estimates and assumptions when determining the fair value of assets acquired and liabilities assumed. These estimates include, but are not limited to, discount rates, projected future revenue growth, cost synergies and expected cash flows, customer attrition rates, useful lives, and other prospective financial information. Additionally, we recognize customer relationships, trademarks and trade names, and non-competition agreements as identifiable intangible assets, which are recorded at fair value as of the transaction date. The fair value of these intangible assets is determined primarily using the income approach and using current industry information.Goodwill is recorded when consideration transferred exceeds the fair value of identifiable assets and liabilities. Measurement-period adjustments to assets acquired and liabilities assumed with a corresponding offset to goodwill are recorded in the period they occur, which may include up to one year from the acquisition date. Contingent consideration is recorded at fair value at the acquisition date.
Recently Issued Accounting Pronouncements
Recently issued accounting pronouncements and their expected or actual effect on
our reported results of operations are addressed in Item 8. Financial Statements
and Supplementary Data - Note 1. Summary of Significant Accounting Policies.
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Off-Balance Sheet Arrangements
As of
Contractual Obligations
The following table provides payment obligations related to current contracts at
Payments Due by Period
2020 2021 2022 2023 2024 Thereafter TotalOperating leases$ 39,500 $ 26,547 $ 16,675 $ 8,650 $ 4,426 $ 5,500 $ 101,298 Principal repayments of long-term debt 34,272 38,961 257,411 6,376 2,130 400,000 739,150 Interest payments and fees on long-term debt (a) 32,642 31,512 25,515 22,678 22,527 30,000 164,874 Purchase obligations (b) 58,045 58,045 - -
- - 116,090 Total$ 164,459 $ 155,065 $ 299,601 $ 37,704 $ 29,083 $ 435,500 $ 1,121,412
Interest and fees have been calculated using the interest rate on our
(a) long-term debt as of
credit remain constant during the term of our Amended Credit Agreement.
We have minimum purchase commitments on certain products through 2021.
(b) Amounts have been calculated using pricing in effect at
non-cancelable minimum contractual obligations by period.
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