7. OTHER COMMITMENTS AND CONTINGENCIES

 

Litigation.  During the second quarter of 2017, we entered into a settlement with Owens in connection with our previously reported breach of contract action related to our termination of an insulation supply agreement.  Under the terms of the settlement, we paid Owens $30 million.  The settlement resulted in the dismissal of the lawsuit filed in May 2016 in Toledo, Ohio.  The settlement is reflected in the significant legal settlement line item within our Condensed Consolidated Statements of Operations for the six months ended June 30, 2017.  The settlement is also reflected in our installation segment’s operating results.

 

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 Matters.  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 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.  Other types of bonds outstanding were principally license and insurance related.

 

8. INCOME TAXES    

 

Our effective tax rates were 38.1 percent and 34.4 percent for the three and six months ended June 30, 2017, respectively. The effective tax rates for the three and six months ended June 30, 2016, were 38.7 percent and 38.8 percent, respectively.  The lower 2017 rates were due to discrete benefits related to share-based compensation and an increase in the amount of the Domestic Production Activities Deduction.

 

A tax benefit of $0.3 million and $1.2 million related to share-based compensation was recognized in our Condensed Consolidated Statements of Operations as a discrete item in income tax expense for the three and six months ended June 30, 2017, respectively.

9. INCOME PER SHARE

 

Basic net income per share is calculated by dividing net income by the weighted average shares outstanding during the period, without consideration for common stock equivalents.

 

Diluted net income per share is calculated by adjusting weighted average shares outstanding for the dilutive effect of common stock equivalents outstanding for the period, determined using the treasury stock method. 

 

Basic and diluted income per share were computed as follows, in thousands, except share and per share amounts:

 

 

The following table summarizes shares excluded from the calculation of diluted income per share because their effect would have been anti-dilutive:

 

 

 

10. SHARE-BASED COMPENSATION

 

Our eligible employees currently participate in the 2015 LTIP.  The 2015 LTIP authorizes the Board to grant stock options, stock appreciation rights, restricted shares, restricted share units, performance awards, and dividend equivalents.  All grants are made by issuing new shares and no more than 4.0 million shares of common stock may be issued under the 2015 LTIP.  As of June 30, 2017, we had 2.8 million shares available under the 2015 LTIP.

 

Share-based compensation expense is included in selling, general, and administrative expense.  The income tax effect associated with award vestings is included in income tax expense.  The following table presents the amounts recognized in our Condensed Consolidated Statements of Operations, in thousands:

 

 

The following table presents a summary of our share-based compensation activity for the six months ended June 30, 2017, in thousands, except per share amounts:

 

 

We had unrecognized share-based compensation expense relating to unvested awards as shown in the following table, dollars in thousands:

 

 

Our RSAs with performance-based conditions are evaluated on a quarterly basis with adjustments to compensation expense based on the likelihood of the performance target being achieved or exceeded.  The following table shows the range of payouts and the related expense for our outstanding RSAs with performance-based conditions, in thousands:

 

The fair value of our RSAs with a market-based condition granted under the 2015 LTIP was determined using a Monte Carlo simulation.  The following are key inputs in the Monte Carlo analysis for awards granted in 2017 and 2016:

 

 

The fair values of stock options granted under the 2015 LTIP were calculated using the Black-Scholes Options Pricing Model.  The following table presents the assumptions used to estimate the fair values of options granted in 2017 and 2016:

 

 

 

11.  SHARE REPURCHASE PROGRAM

 

On March 1, 2016, our Board authorized the 2016 Repurchase Program, which expired on February 28, 2017.  We repurchased a total of 788,399 shares for an approximate cost of $26.6 million, or $33.72 per share, under the 2016 Repurchase Plan.

 

On February 24, 2017, our Board authorized the 2017 Repurchase Program, pursuant to which we may purchase up to $200 million of our common stock.  Share repurchases under the 2017 Repurchase Program may be executed through various means including, without limitation, open market purchases, privately negotiated transactions, or otherwise.  The 2017 Repurchase Program does not obligate the Company to purchase any shares and expires February 24, 2019.  Authorization for the 2017 Repurchase Program may be terminated, increased, or decreased by our Board at its discretion at any time.

 

The following table sets forth our share repurchases under the 2016 and 2017 Share Repurchase Programs:

 

 

 

On May 5, 2017, we entered into the 2017 ASR Agreement.  The agreement became effective on July 5, 2017.  Upon the effectiveness of the agreement, we delivered to BofA $100.0 million in exchange for an initial delivery of a number of shares of our common stock.  The actual number of shares to be repurchased under the 2017 ASR Agreement will be based on the average of the daily volume-weighted average prices paid for our common stock during the term of the transaction, less an agreed discount, and subject to potential adjustments pursuant to the terms and conditions of the agreement.  The final settlement of the transaction under the agreement is expected to occur no later than the first quarter of 2018.  At final settlement, BofA may be required to deliver additional shares of common stock to us, or, under certain circumstances, we may be required to deliver shares of our common stock or to make a cash payment, at our election, to BofA.

 

The 2017 ASR Agreement is part of our 2017 Repurchase Program.  For more information, see Note 14 – Subsequent Events.

 

 

 

 

 

12.  BUSINESS COMBINATIONS

 

As part of our strategy to supplement our organic growth and expand our access to additional markets and products, we made several acquisitions during the six months ended June 30, 2017.  Each acquisition was accounted for as a business combination under ASC Topic 805, “Business Combinations.”  Acquisition related costs for the three and six months ended June 30, 2017, were $0.1 million and $0.4 million, respectively and are included in selling, general, and administrative expense in our Condensed Consolidated Statements of Operations.

 

Acquisitions

 

On January 16, 2017, we acquired substantially all of the assets of Midwest, a heavy commercial fireproofing and insulation company with locations in Chicago, Illinois and Indianapolis, Indiana.  The purchase price of approximately $12.2 million was funded by cash on hand.

 

On February 27, 2017, we acquired substantially all of the assets of EcoFoam, a residential and light commercial insulation installation company with locations in Colorado Springs and Denver, Colorado.  The purchase price of approximately $22.3 million was funded by cash on hand of $20.2 million and contingent consideration of $2.1 million.

 

On February 27, 2017, we acquired substantially all of the assets of MR Insulfoam, a residential insulation installation company located in Norwalk, Connecticut.  The purchase price of approximately $1.5 million was funded by cash on hand.

 

On March 29, 2017, we acquired substantially all of the assets of Capital, a residential insulation installation company located in Sacramento, California.  The purchase price of approximately $7.3 million was funded by cash on hand.

 

On April 20, 2017, we acquired substantially all of the assets of Superior, a residential insulation installation company located in Seattle, Washington.  The purchase price of approximately $10.9 million was funded by cash on hand.

 

On June 8, 2017, we acquired substantially all of the assets of Canyon, a heavy commercial insulation and firestopping company with locations in Corona, San Diego, and Livermore, California.  The purchase price of approximately $34.4 million was funded by cash on hand of $31.8 million and deferred purchase price consideration of $2.7 million.

 

Revenue and net income since the acquisition date included in our Condensed Consolidated Statements of Operations were as follows, in thousands:

 

 

Pro Forma Results

 

The following unaudited pro forma information has been prepared as if the 2017 acquisitions had taken place on January 1, 2016.  The unaudited pro forma information is not necessarily indicative of the results that we would have achieved had the transactions actually taken place on January 1, 2016.  Further, the pro forma information does not purport to be indicative of future financial operating results.  Our pro forma results are presented below, in thousands:

 

 

The following table details the additional expense included in the unaudited pro forma net income that would have been recorded had the acquisitions taken place on January 1, 2016, in thousands:

 

 

Purchase Price Allocations

 

The estimated fair values of the assets acquired and liabilities assumed for the acquisitions, as well as total consideration paid, approximated the following as of June 30, in thousands:

 

 

The following table details the fair value of consideration transferred as of June 30, in thousands:

 

 

Estimates of acquired intangible assets related to the acquisitions are as follows, as of June 30, dollars in thousands:

 

 

Further adjustments to the allocation for each acquisition still under its measurement period, generally one year from acquisition date, are expected as third-party or internal valuations are finalized, certain tax aspects of the transaction are completed, and customary post-closing reviews are concluded during the measurement period attributable to each individual business combination.  Insignificant adjustments to the fair value of assets acquired, and in some cases total purchase price, have been made to certain business combinations since the date of acquisition.  Adjustments may be made to the fair value of assets acquired, and in some cases total purchase price may be adjusted, through the end of each measurement period.

 

Goodwill to be recognized in connection with these acquisitions is attributable to the synergies expected to be realized and improvements in the businesses after the acquisitions.  The goodwill will be recognized entirely by our Installation segment.  All of the $39.8 million of goodwill is expected to be deductible for income tax purposes.

 

Contingent Consideration

 

The acquisition of EcoFoam includes a contingent consideration arrangement that requires additional consideration to be paid by TopBuild to the sellers of EcoFoam based on certain future revenues of EcoFoam over a three-year period.  The range of the undiscounted amounts TopBuild could pay under the contingent consideration agreement is between zero and $2.5 million.  The fair value of the contingent consideration recognized on the acquisition date of $2.1 million was estimated by applying the income approach using discounted cash flows.  That measure is based on significant Level 3 inputs not observable in the market.  The significant assumption includes a discount rate of 9.5%.

 

Contingent consideration is recorded in the Condensed Consolidated Balance Sheets in accrued liabilities and other liabilities.  Adjustments to the fair value of contingent consideration will be reflected in selling, general, and administrative expense in the Condensed Consolidated Statements of Operations and are included in the acquisition related costs above.  The following table presents the fair value of contingent consideration as of June 30, 2017, in thousands:

 

 

 

13.  CLOSURE COSTS

 

We continuously evaluate our national footprint to ensure we are strategically located throughout the U.S. to serve our customers and position ourselves for continued growth.  As a result of this evaluation, management approved a plan to consolidate certain back-office support operations to our Daytona Beach, Florida, Branch Support Center.  We recognize expenses related to closures and position eliminations at the time of announcement or notification.  Such costs included termination and other severance benefits, lease abandonment costs, and other transition costs.  Closure costs are reflected in our Condensed Consolidated Statements of Operations as selling, general, and administrative expense.    Accrued closure costs are reflected in our Condensed Consolidated Balance  Sheets as accrued liabilities.  Remaining accrued closure costs are expected to be paid within the next three to six months, except our lease termination costs, which we expect to be paid over the following three years.

 

The following table details our total estimated closure costs, by cost type, related to the above closure and transition costs, in thousands:

 

 

 

 

 

 

14.  SUBSEQUENT EVENTS

 

On May 5, 2017, we entered into the 2017 ASR Agreement as part of our 2017 Repurchase Program.  On July 5, 2017, we made a payment of $100.0 million and received an initial share delivery of approximately 1.5 million shares worth approximately $80.0 million.  The remaining balance of $20.0 million is expected to settle no later than March 2018.  The actual number of shares to be repurchased will be based on the average of the daily volume-weighted average prices of our common stock repurchased during the term of the transaction, less an agreed discount.  At final settlement, BofA may be required to deliver additional shares of common stock to us, or, under certain circumstances, we may be required to deliver shares of our common stock or make a cash payment, at our election, to BofA. 

 

During July 2017, we used $30.0 million of cash on hand and borrowed $70.0 million under our Revolving Facility to fund the 2017 ASR Agreement. 

 

 

 

 

 

Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

OVERVIEW

 

TopBuild, headquartered in Daytona Beach, Florida, is the leading purchaser, installer, and distributor of insulation products to the U.S. construction industry, based on revenue.  We trade on the NYSE under the symbol “BLD.”

 

We operate in two segments:  Installation (TruTeam) and Distribution (Service Partners).  Through our Installation segment, we provide insulation installation services nationwide through our TruTeam contractor services business which has over 175 branches located in 41 states.  We install various insulation applications, including fiberglass batts and rolls, blown-in loose fill fiberglass, blown-in loose fill cellulose, and polyurethane spray foam.  Additionally, we install other building products, including rain gutters, garage doors, fireplaces, shower enclosures, and closet shelving.  We handle every stage of the installation process, including material procurement supplied by leading manufacturers, project scheduling and logistics, multi-phase professional installation, and installation quality assurance. 

 

Through our Distribution segment, we distribute insulation and other building products, including rain gutters, fireplaces, closet shelving, and roofing materials through our Service Partners business, which has over 70 branches in 32 states.  Our Service Partners customer base consists of thousands of insulation contractors of all sizes, gutter contractors, weatherization contractors, other contractors, dealers, metal building erectors, and modular home builders.

 

We believe that having both TruTeam and Service Partners provides us with a number of distinct competitive advantages.  First, the combined buying power of our two business segments, along with our national scale, strengthens our ties to the major manufacturers of insulation and other building products.  This helps to ensure we are buying competitively and ensures the availability of supply to our local branches and distribution centers.   The overall effect is driving efficiencies through our supply chain.  Second, being a leader in both installation and distribution allows us to more effectively reach a broader set of builder customers, regardless of their size or geographic location in the U.S., and leverage housing growth wherever it occurs.   Third, during industry downturns, many insulation contractors who buy directly from manufacturers during industry peaks return to purchasing through distributors.  As a result, this helps to reduce our exposure to cyclical swings in our business. 

 

For additional details pertaining to our operating results by segment see Note 6 – Segment Information in the notes to the unaudited condensed consolidated financial statements, which is incorporated herein by reference.

 

SECOND QUARTER 2017 VERSUS SECOND QUARTER 2016

 

The following discussion and analysis contains forward-looking statements and should be read in conjunction with the unaudited condensed consolidated financial statements, the notes thereto, and the section entitled “Forward-Looking Statements” included elsewhere in this Quarterly Report on Form 10-Q.

 

The following table sets forth our net sales, gross profit, operating profit, and margins, as reported in our Condensed Consolidated Statements of Operations, in thousands:

 

 

Sales and Operations

 

Net sales increased 9.9 percent for the three months ended June 30, 2017, from the comparable period of 2016.  The increase was principally driven by increased organic sales volume, overall increased selling prices as well as our seven acquisitions completed during 2017 and 2016.  Our sales benefited from the overall continued improvement in the housing market, as well as our continued focus on organically growing our residential and commercial activity.

 

The following table details our same branch sales and sales from acquired businesses, in thousands:

 

 

Our gross profit margins were 24.6 percent and 22.6 percent for the three months ended June 30, 2017 and 2016, respectively.  Gross profit margin was positively impacted by favorable leverage on overall higher sales volume, improved selling prices, improved labor productivity, lower material costs, and lower health insurance costs.

 

Selling, general, and administrative expense, as a percent of sales, was 16.0 percent and 16.4 percent for the three months ended June 30, 2017 and 2016, respectively.  Decreased selling, general, and administrative expense as a percent of sales was a result of better absorption of fixed costs, lower salaries expense, and lower workers’ compensation and general insurance expense, partially offset by higher share-based compensation and legal expenses.  Operating margins were 8.6 percent and 6.2 percent for the three months ended June 30, 2017 and 2016, respectively.  The increase in operating margins was a result of better absorption of fixed costs, overall increased sales volume, improved selling prices, lower material cost, improved labor productivity, and lower salaries expense, partially offset by higher share-based compensation and legal expenses, as well as closure and related costs noted below.

 

Closure and Related Costs

 

We incurred expense of $0.5 million during the three months ended June 30, 2017, related to the consolidation of certain back-office operations to our Daytona Beach, Florida, Branch Support Center.

 

Business Segment Results

 

The following table sets forth our net sales and operating profit margins by business segment, in thousands:

 

 

Installation

 

Sales

 

Sales in the Installation segment increased $32.9 million, or 11.4 percent, for the three months ended June 30, 2017, compared to the same period in 2016.  Sales increased 7.2 percent from acquired branches and 1.5 percent due to increased selling prices.  Sales also increased due to increased sales volume related to a higher level of activity in new home construction and an increased sales volume of commercial installation.

 

Operating results

 

Operating margins in the Installation segment were 10.9 percent and 7.9 percent for the three months ended June 30, 2017 and 2016, respectively.  The increase in operating margins was a result of increased sales volume and related absorption of fixed costs, a 1.5 percent increase in selling prices, lower material cost, improved sales productivity, lower health insurance costs, as well as the benefits associated with cost savings initiatives, partially offset by higher legal fees.

 

Distribution

 

Sales

 

Sales in the Distribution segment increased $10.8 million, or 6.6 percent, for the three months ended June 30, 2017, compared to the same period in 2016.  The increase was primarily due to increased sales volume related to a higher level of activity in new home construction.  Sales were partially offset by a 0.2 percent decrease in selling prices.

 

Operating results

 

Operating margins in the Distribution segment were 9.7 percent and 8.2 percent for the three months ended June 30, 2017 and 2016, respectively.  The increase in operating margins was a result of better absorption of fixed costs and increased sales volume.  Sales volume increased due to a higher level of activity in new home construction as well as lower material costs, partially offset by selling price degradation.

 

OTHER ITEMS

 

Other expense, net

 

Other expense, net, which primarily consisted of interest expense, was $2.9 million and $1.3 million for the three months ended June 30, 2017 and 2016, respectively.  The increase in other expense, net for the three months ended June 30, 2017, primarily related to a $1.1 million loss on extinguishment of debt as a result of our debt refinancing completed on May 5, 2017.

 

Income tax expense from continuing operations

 

Income tax expense from continuing operations was $14.4 million, an ETR of 38.1 percent, for the three months ended June 30, 2017, compared to $9.9 million, an ETR of 38.7 percent, for the comparable period in 2016.  The lower 2017 rate was due to a discrete benefit related to share-based compensation and an increase in the amount of the Domestic Production Activities Deduction.

FIRST SIX MONTHS 2017 VERSUS FIRST SIX MONTHS 2016

 

The following table sets forth our net sales, gross profit, operating profit, and margins, as reported in our Condensed Consolidated Statements of Operations, in thousands:

 

 

Sales and Operations

 

Net sales increased 8.3 percent for the six months ended June 30, 2017, from the comparable period of 2016.  The increase was principally driven by increased organic sales volume, overall increased selling prices as well as our seven acquisitions completed during 2017 and 2016.  Our sales benefited from the overall continued improvement in the housing market, as well as our continued focus on organically growing our residential and commercial activity.

 

The following table details our same branch sales and sales from acquired businesses, in thousands:

 

 

Our gross profit margins were 23.8 percent and 22.1 percent for the six months ended June 30, 2017 and 2016, respectively.  Gross profit margin was positively impacted by favorable leverage on overall higher sales volume, higher selling prices, lower material costs, and lower health insurance costs.

 

Selling, general, and administrative expense, exclusive of the significant legal settlement discussed below, as a percent of sales, was 16.5 percent and 16.6 percent for the six months ended June 30, 2017 and 2016, respectively.  Decreased selling, general, and administrative expense as a percent of sales was a result of lower salaries and group health expense, partially offset by higher legal and share-based compensation expense, as well as closure and related costs noted below.  We incurred a $30 million legal settlement during

the six months ended June 30, 2017, related to the settlement of a breach of contract action related to our termination of an insulation supply agreement with Owens.  Operating margins, exclusive of the significant legal settlement discussed above were 7.4 percent and 5.5 percent for the six months ended June 30, 2017 and 2016, respectively.  The increase in operating margins was a result of overall increased sales volume, higher selling prices, lower material cost, and lower health insurance costs, partially offset by higher legal fees, share-based compensation expense, and bonus expense.

 

Closure and Related Costs

 

We incurred expense of $1.7 million during the six months ended June 30, 2017, related to the consolidation of certain back-office operations to our Daytona Beach, Florida, Branch Support Center.

 

Business Segment Results

 

The following table sets forth our net sales and operating profit margins by business segment, in thousands:

 

 

Installation

 

Sales

 

Sales in the Installation segment increased $51.0 million, or 9.1 percent, for the six months ended June 30, 2017, compared to the same period in 2016.  Sales increased 5.1 percent from acquired branches and 1.6 percent due to increased selling prices.  Sales also increased due to increased sales volume related to a higher level of activity in new home construction and an increased sales volume of commercial installation.

 

Operating results