Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE
COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2020
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 001-36870
TopBuild Corp.
(Exact name of Registrant as Specified in its Charter)
Delaware
(State or Other Jurisdiction of Incorporation orOrganization)
47-3096382
(I.R.S. EmployerIdentification No.)
475 North Williamson Boulevard
Daytona Beach, Florida
(Address of Principal Executive Offices)
32114
(Zip Code)
(386) 304-2200
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common stock, par value $0.01 per share
BLD
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.⌧ Yes ◻ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ⌧ Yes ◻ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☒ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☐ Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No
The registrant had outstanding 33,024,441 shares of Common Stock, par value $0.01 per share as of October 30, 2020.
TOPBUILD CORP.
TABLE OF CONTENTS
Page No.
Part I.
Financial Information
Item 1.
Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets
4
Condensed Consolidated Statements of Operations
5
Condensed Consolidated Statements of Cash Flows
6
Condensed Consolidated Statements of Changes in Equity
7
Notes to Condensed Consolidated Financial Statements
8
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
23
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
30
Item 4.
Controls and Procedures
31
Part II.
Other Information
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults upon Senior Securities
32
Mine Safety Disclosures
Item 5.
Item 6.
Exhibits
Index to Exhibits
33
Signature
34
2
GLOSSARY
We use acronyms, abbreviations, and other defined terms throughout this quarterly report on Form 10-Q, which are defined in the glossary below:
Term
Definition
2015 LTIP
2015 Long-Term Incentive program authorizes the Board to grant stock options, stock appreciation rights, restricted shares, restricted share units, performance awards, and dividend equivalents
2017 Repurchase Program
$200 million share repurchase program authorized by the Board on February 24, 2017
2018 ASR Agreement
$50 million accelerated share repurchase agreement with JPMorgan Chase Bank, N.A.
2019 Repurchase Program
$200 million share repurchase program authorized by the Board on February 22, 2019
2019 ASR Agreement
$50 million accelerated share repurchase agreement with Bank of America, N.A.
Amended Credit Agreement
Senior secured credit agreement and related security and pledge agreement dated March 20, 2020
Annual Report
Annual report filed with the SEC on Form 10-K pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
ASC
Accounting Standards Codification
ASU
Accounting Standards Update
Board
Board of Directors of TopBuild
BofA
Bank of America, N.A.
Cooper
Cooper Glass Company, LLC
Current Report
Current report filed with the SEC on Form 8-K pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
EBITDA
Earnings before interest, taxes, depreciation, and amortization
EcoFoam
Bella Insulutions Inc., DBA EcoFoam/Insulutions
Exchange Act
The Securities Exchange Act of 1934, as amended
FASB
Financial Accounting Standards Board
GAAP
Generally accepted accounting principles in the United States of America
Garland
Garland Insulating
Hunter
Hunter Insulation
IBR
Incremental borrowing rate, as defined in ASC 842
Lenders
Bank of America, N.A., together with the other lenders party to the "Amended Credit Agreement"
LIBOR
London interbank offered rate
Net Leverage Ratio
As defined in the “Amended Credit Agreement,” the ratio of outstanding indebtedness, less up to $100 million of unrestricted cash, to EBITDA
NYSE
Original Credit Agreement
Senior secured credit agreement and related security and pledge agreement dated May 5, 2017, as amended March 28, 2018
Quarterly Report
Quarterly report filed with the SEC on Form 10-Q pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Revolving Facility
Senior secured revolving credit facilities available under the Amended Credit Agreement, of $450 million with applicable sublimits for letters of credit and swingline loans.
ROU
Right of use (asset), as defined in ASC 842
RSA
Restricted stock award
Santa Rosa
Santa Rosa Insulation and Fireproofing, LLC
SEC
United States Securities and Exchange Commission
Secured Leverage Ratio
As defined in the “Amended Credit Agreement,” the ratio of outstanding indebtedness, including letters of credit, to EBITDA
Senior Notes
TopBuild's 5.625% senior unsecured notes due on May 1, 2026
TopBuild
TopBuild Corp. and its wholly-owned consolidated domestic subsidiaries. Also, the "Company," "we," "us," and "our"
Viking
Viking Insulation Co.
3
PART I – FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In thousands except share data)
As of
September 30,
December 31,
2020
2019
ASSETS
Current assets:
Cash and cash equivalents
$
315,338
184,807
Receivables, net of an allowance for credit losses of $8,122 at September 30, 2020, and allowance for doubtful accounts of $4,854 at December 31, 2019
436,548
428,844
Inventories, net
142,517
149,078
Prepaid expenses and other current assets
32,101
17,098
Total current assets
926,504
779,827
Right of use assets
81,692
87,134
Property and equipment, net
172,099
178,080
Goodwill
1,379,721
1,367,918
Other intangible assets, net
172,390
181,122
Deferred tax assets, net
4,397
4,259
Other assets
10,998
5,623
Total assets
2,747,801
2,603,963
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable
311,696
307,970
Current portion of long-term debt
23,247
34,272
Accrued liabilities
117,456
98,418
Short-term lease liabilities
32,747
36,094
Total current liabilities
485,146
476,754
Long-term debt
688,870
697,955
Deferred tax liabilities, net
173,597
175,263
Long-term portion of insurance reserves
49,927
45,605
Long-term lease liabilities
52,672
54,010
Other liabilities
15,995
1,487
Total liabilities
1,466,207
1,451,074
Commitments and contingencies
Equity:
Preferred stock, $0.01 par value: 10,000,000 shares authorized; 0 shares issued and outstanding at September 30, 2020 and December 31, 2019
—
Common stock, $0.01 par value: 250,000,000 shares authorized; 39,030,810 shares issued and 33,053,795 outstanding at September 30, 2020, and 38,884,530 shares issued and 33,489,769 outstanding at December 31, 2019
389
388
Treasury stock, 5,977,015 shares at September 30, 2020, and 5,394,761 shares at December 31, 2019, at cost
(380,667)
(330,018)
Additional paid-in capital
855,972
849,657
Retained earnings
805,900
632,862
Total equity
1,281,594
1,152,889
Total liabilities and equity
See notes to our unaudited condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands except share and per common share data)
Three Months Ended September 30,
Nine Months Ended September 30,
Net sales
697,223
682,330
1,996,551
1,961,771
Cost of sales
498,895
502,999
1,448,210
1,451,822
Gross profit
198,328
179,331
548,341
509,949
Selling, general, and administrative expense
96,805
98,886
296,372
296,846
Operating profit
101,523
80,445
251,969
213,103
Other income (expense), net:
Interest expense
(7,692)
(9,507)
(24,711)
(28,740)
Loss on extinguishment of debt
(233)
Other, net
86
653
648
1,512
Other expense, net
(7,606)
(8,854)
(24,296)
(27,228)
Income before income taxes
93,917
71,591
227,673
185,875
Income tax expense
(23,921)
(16,615)
(51,407)
(40,864)
Net income
69,996
54,976
176,266
145,011
Net income per common share:
Basic
2.13
1.63
5.35
4.27
Diluted
2.11
1.60
5.29
4.20
Weighted average shares outstanding:
32,847,652
33,790,857
32,960,969
33,977,464
33,210,545
34,367,902
33,337,259
34,541,635
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In thousands)
Cash Flows Provided by (Used in) Operating Activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
47,527
39,005
Share-based compensation
12,159
11,411
233
Loss on sale or abandonment of property and equipment
290
885
Amortization of debt issuance costs
1,103
1,169
Provision for bad debt expense
5,625
5,697
Loss from inventory obsolescence
1,908
1,794
Deferred income taxes, net
(709)
(381)
Change in certain assets and liabilities
Receivables, net
(13,645)
(51,585)
4,759
20,637
(14,989)
10,003
2,152
(12,529)
33,436
10,758
Payment of contingent consideration
(413)
21
904
Net cash provided by operating activities
255,723
182,779
Cash Flows Provided by (Used in) Investing Activities:
Purchases of property and equipment
(27,206)
(34,100)
Acquisition of businesses
(21,450)
(6,452)
Proceeds from sale of property and equipment
2,332
2,239
25
Net cash used in investing activities
(46,324)
(38,288)
Cash Flows Provided by (Used in) Financing Activities:
Proceeds from issuance of long-term debt
300,000
9,998
Repayment of long-term debt
(319,168)
(19,424)
Payment of debt issuance costs
(2,280)
Taxes withheld and paid on employees' equity awards
(14,781)
(11,135)
Exercise of stock options
1,438
Repurchase of shares of common stock
(43,149)
(52,177)
(928)
(1,091)
Net cash used in financing activities
(78,868)
(73,829)
Cash and Cash Equivalents
Increase for the period
130,531
70,662
Beginning of period
100,929
End of period
171,591
Supplemental disclosure of noncash activities:
Leased assets obtained in exchange for new operating lease liabilities
27,098
120,726
Accruals for property and equipment
278
102
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (Unaudited)
Common
Treasury
Additional
Stock
Paid-in
Retained
($0.01 par value)
at cost
Capital
Earnings
Equity
Balance at December 31, 2018
387
(216,607)
846,451
441,867
1,072,098
37,983
2,972
Issuance of 112,270 restricted share awards under long-term equity incentive plan
1
(1)
Repurchase of 176,327 shares pursuant to the settlement of the 2018 ASR Agreement
(10,000)
10,000
Repurchase of 72,791 shares
(4,622)
105,615 shares withheld to pay taxes on employees' equity awards
(5,578)
Balance at March 31, 2019
(231,229)
853,844
479,850
1,102,853
52,051
4,513
Repurchase of 196,885 shares
(14,878)
54,811 shares withheld to pay taxes on employees' equity awards
(2,893)
Balance at June 30, 2019
(246,107)
855,464
531,901
1,141,646
3,926
Repurchase of 364,074 shares
(32,677)
43,037 shares withheld to pay taxes on employees' equity awards
(2,664)
Balance at September 30, 2019
(278,784)
856,726
586,877
1,165,207
Balance at December 31, 2019
50,771
3,908
Cumulative-effect of accounting change
(3,225)
Issuance of 63,780 restricted share awards under long-term equity incentive plan
Repurchase of 73,455 shares pursuant to the settlement of the 2019 ASR Agreement
(7,500)
7,500
Repurchase of 188,100 shares
(14,127)
97,144 shares withheld to pay taxes on employees' equity awards
(10,399)
Balance at March 31, 2020
(351,645)
850,665
680,408
1,179,817
55,496
5,130
Repurchase of 262,889 shares
(20,025)
38,379 shares withheld to pay taxes on employees' equity awards
(2,766)
Balance at June 30, 2020
(371,670)
853,029
735,904
1,217,652
3,121
Repurchase of 57,810 shares
(8,997)
6,402 shares withheld to pay taxes on employees' equity awards
(1,616)
19,242 shares issued upon exercise of stock options
Balance at September 30, 2020
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. BASIS OF PRESENTATION
TopBuild was formed on June 30, 2015, and is listed on the NYSE under the ticker symbol “BLD.” We report our business in two segments: Installation and Distribution. Our Installation segment primarily installs insulation and other building products. Our Distribution segment primarily sells and distributes insulation and other building products. Our segments are based on our operating units, for which financial information is regularly evaluated by our chief operating decision maker.
In our opinion, the accompanying unaudited condensed consolidated financial statements contain all adjustments, of a normal recurring nature, necessary to state fairly our financial position as of September 30, 2020, our results of operations for the three and nine months ended September 30, 2020 and 2019 and cash flows for the nine months ended September 30, 2020 and 2019. The condensed consolidated balance sheet at December 31, 2019, was derived from our audited financial statements, but does not include all disclosures required by GAAP.
These condensed consolidated financial statements and related notes should be read in conjunction with the audited Consolidated Financial Statements included in the Company’s Annual Report for the year ended December 31, 2019, as filed with the SEC on February 25, 2020.
2. ACCOUNTING POLICIES
Financial Statement Presentation. Our condensed consolidated financial statements have been developed in conformity with GAAP, which requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosures of contingent liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from these estimates. All intercompany transactions between TopBuild entities have been eliminated.
Recently Adopted Accounting Pronouncements
Credit Losses
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments,” which replaces the current incurred loss methodology with an expected loss methodology, referred to as the current expected credit loss (CECL) methodology. We adopted Topic 326 on January 1, 2020, using the modified retrospective method, which resulted in a $3.2 million cumulative-effect adjustment recorded through retained earnings at the beginning of 2020.
We measure the expected credit losses on accounts receivable by segment, using historical loss rate information adjusted for current conditions, with changes in the allowance recorded as a provision for (or reversal of) credit loss expense. Expected losses are charged against the allowance when management believes a receivable is uncollectible. Receivables, net are presented net of certain allowances, including allowance for credit losses.
Goodwill Impairment
In January 2017, the FASB issued ASU 2017-04, “Intangibles – Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment.” The new standard simplifies the subsequent measurement of goodwill by eliminating the second step of the goodwill impairment test. This update was effective for us beginning January 1, 2020, and did not have a material impact on our financial position and results of operations.
TOPBUILD CORP.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Fair Value
In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820), Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement.” The new standard modifies the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, including adjustments to Level 3 fair value measurement disclosures as well as the removal of disclosures around Level 1 and Level 2 transfers. This update was effective for us beginning January 1, 2020, and did not have a material impact on our financial position and results of operations.
Recently Issued Accounting Pronouncements Not Yet Adopted
In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740), Simplifying the Accounting for Income Taxes.” This standard simplifies the accounting for income taxes by removing certain exceptions to the general principles included in current guidance, as well as improving consistent application of and simplifying GAAP for other areas by clarifying and amending existing guidance. This update is effective for us beginning January 1, 2021, with early adoption permitted. We plan to adopt this standard on January 1, 2021 and we do not anticipate that the adoption will have a material impact on our financial position and results of operations.
3. REVENUE RECOGNITION
Revenue is disaggregated between our Installation and Distribution segments and further based on market and product, as we believe this best depicts how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors. The following tables present our revenues disaggregated by market (in thousands):
Installation
Distribution
Elims
Total
Residential
390,101
186,408
(30,821)
545,688
386,887
165,200
(29,581)
522,506
Commercial
102,105
57,705
(8,275)
151,535
111,503
55,747
(7,426)
159,824
492,206
244,113
(39,096)
498,390
220,947
(37,007)
1,134,350
512,479
(88,875)
1,557,954
1,110,704
478,753
(86,157)
1,503,300
300,298
162,193
(23,894)
438,597
320,096
160,146
(21,771)
458,471
1,434,648
674,672
(112,769)
1,430,800
638,899
(107,928)
The following tables present our revenues disaggregated by product (in thousands):
Insulation and accessories
379,958
200,210
(31,816)
548,352
388,796
182,111
(27,872)
543,035
Glass and windows
41,912
37,885
Gutters
21,336
28,616
(5,482)
44,470
23,177
24,056
(7,270)
39,963
All other
49,000
15,287
(1,798)
62,489
48,532
14,780
(1,865)
61,447
9
1,110,952
556,018
(91,422)
1,575,548
1,116,292
525,717
(83,888)
1,558,121
122,603
114,839
61,843
74,585
(16,557)
119,871
63,669
65,707
(19,151)
110,225
139,250
44,069
(4,790)
178,529
136,000
47,475
(4,889)
178,586
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.
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, 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. Our remaining performance obligations are expected to be recognized within the next twelve months.
The following table represents our contract assets and contract liabilities with customers, in thousands:
Included in Line Item on
Condensed Consolidated
Balance Sheets
Contract Assets:
Receivables, unbilled
54,375
57,153
Contract Liabilities:
Deferred revenue
16,817
16,139
10
4. GOODWILL AND OTHER INTANGIBLES
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.
In the fourth quarter of 2019, we performed an annual assessment on our goodwill resulting in no impairment.
Changes in the carrying amount of goodwill for the nine months ended September 30, 2020 by segment, were as follows, in thousands:
Gross Goodwill
Accumulated
Net Goodwill
at
Impairment
December 31, 2019
Additions
September 30, 2020
Losses
Goodwill, by segment:
1,683,589
11,803
1,695,392
(762,021)
933,371
446,350
Total goodwill
2,129,939
2,141,742
See Note 13 – Business Combinations for goodwill recognized on acquisitions that occurred in the first half of 2020.
Other intangible assets, net includes customer relationships, non-compete agreements, and trademarks / trade names. The following table sets forth our other intangible assets, in thousands:
Gross definite-lived intangible assets
228,662
221,382
Accumulated amortization
(56,272)
(40,260)
Net definite-lived intangible assets
Indefinite-lived intangible assets not subject to amortization
The following table sets forth our amortization expense, in thousands:
Amortization expense
5,382
5,197
16,012
15,543
11
5. LONG-TERM DEBT
The following table reconciles the principal balances of our outstanding debt to our condensed consolidated balance sheets, in thousands:
Senior Notes - 5.625% due May 2026
400,000
Term loan
292,500
305,625
Equipment notes
27,484
33,525
Unamortized debt issuance costs
(7,867)
(6,923)
Total debt, net of unamortized debt issuance costs
712,117
732,227
Less: current portion of long-term debt
Total long-term debt
The following table sets forth our remaining principal payments for our outstanding debt balances as of September 30, 2020, in thousands:
Payments Due by Period
2021
2022
2023
2024
Thereafter
3,750
15,000
20,625
22,500
28,125
202,500
2,040
8,326
8,651
6,337
2,130
5,790
23,326
29,276
28,837
30,255
602,500
719,984
Amended Credit Agreement and Senior Secured Term Loan Facility
On March 20, 2020, the Company entered into an Amended Credit Agreement, which renewed, amended and restated the Original Credit Agreement in its entirety. The Amended Credit Agreement provides for a term loan facility in an aggregate principal amount of $300.0 million, all of which was drawn on March 20, 2020 and a Revolving Facility with an aggregate borrowing capacity of $450.0 million, including a $100.0 million letter of credit sublimit and up to a $35.0 million swingline sublimit. The maturity date for the loans under the Amended Credit Agreement was extended from May 2022 to March 2025.
The following table outlines the key terms of our Amended Credit Agreement (dollars in thousands):
Senior secured term loan facility
Additional term loan and/or revolver capacity available under incremental facility (a)
450,000
Sublimit for issuance of letters of credit under Revolving Facility (b)
100,000
Sublimit for swingline loans under Revolving Facility (b)
35,000
Interest rate as of September 30, 2020
1.50
%
Scheduled maturity date
3/20/2025
12
Interest payable on borrowings under the Amended Credit Agreement is based on an applicable margin rate plus, at our option, either:
The Amended Credit Agreement contemplates future amendment by the Company and the agent to provide for the replacement of LIBOR with the Secured Overnight Financing Rate or another alternate benchmark rate, giving due consideration to any evolving or then existing convention for similar U.S. dollar denominated syndicated credit facilities for such alternative benchmarks, including any related mathematical or other applicable adjustments.
The applicable margin rate is determined based on our Secured Leverage Ratio. In the case of base rate borrowings, the applicable margin rate ranges from 0.00 percent to 1.50 percent and in the case of LIBOR rate borrowings, the applicable margin ranges from 1.00 percent to 2.50 percent. Borrowings under the Amended Credit Agreement are prepayable at the Company’s option without premium or penalty. The Company is required to make prepayments with the net cash proceeds of certain asset sales and certain extraordinary receipts.
The Company has outstanding standby letters of credit that secure our financial obligations related to our workers’ compensation, general insurance, and auto liability programs. These standby letters of credit, as well as any outstanding amount borrowed under our Revolving Facility, reduce the availability under the Revolving Facility. The following table summarizes our availability under the Revolving Facility, in thousands:
250,000
Less: standby letters of credit
(60,382)
(61,382)
Availability under Revolving Facility
389,618
188,618
We are required to pay commitment fees to the Lenders in respect of any unutilized commitments. The commitment fees range from 0.15 percent to 0.275 percent per annum, depending on our Secured Leverage Ratio. We must also pay customary fees on outstanding letters of credit.
The Senior Notes are our senior unsecured obligations and bear interest at 5.625% per year, payable semiannually in arrears on May 1 and November 1 of each year, which began on November 1, 2018. The Senior Notes mature on May 1, 2026, unless redeemed early or repurchased. We have the right to redeem the Senior Notes under certain circumstances, and, if we undergo a change in control, we must make an offer to repurchase all of the Senior Notes then outstanding at a repurchase price equal to 101% of their aggregate principal amount, plus accrued and unpaid interest (if any) to, but not including, the repurchase date.
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Equipment Notes
As of December 31, 2019, the company has issued $41.6 million of equipment notes for the purpose of financing the purchase of vehicles and equipment. No equipment notes were issued during the nine months ended September 30, 2020. The Company’s equipment notes each have a five year term maturing from 2023 to 2024 and bear interest at fixed rates between 2.8% and 4.4%.
Covenant Compliance
The indenture governing our Senior Notes contains customary restrictive covenants that, among other things, generally limit our ability to incur additional debt and issue preferred stock; to create liens; to pay dividends, acquire shares of capital stock, make payments on subordinated debt or make investments; to place limitations on distributions from certain subsidiaries; to issue guarantees; to issue or sell the capital stock of certain subsidiaries; to sell assets; to enter into transactions with affiliates; and to effect mergers. The Senior Notes indenture also contains customary events of default, subject in certain cases to grace and cure periods. Generally, if an event of default occurs and is continuing, the trustee under the indenture or the holders of at least 25% in aggregate principal amount of the Senior Notes then outstanding may declare the principal of, premium, if any, and accrued interest on all the Senior Notes immediately due and payable. The Senior Notes and related guarantees have not been registered under the Securities Act of 1933, and we are not required to register either the Senior Notes or the guarantees in the future.
The Amended Credit Agreement contains certain covenants that limit, among other things, the ability of the Company to incur additional indebtedness or liens; to make certain investments or loans; to make certain restricted payments; to enter into consolidations, mergers, sales of material assets, and other fundamental changes; to transact with affiliates; to enter into agreements restricting the ability of subsidiaries to incur liens or pay dividends; or to make certain accounting changes. The Amended Credit Agreement contains customary affirmative covenants and events of default.
The Amended Credit Agreement requires that we maintain a Net Leverage Ratio and minimum Interest Coverage Ratio throughout the term of the agreement. The following table outlines the key financial covenants effective for the period covered by this Quarterly Report:
As of September 30, 2020
Maximum Net Leverage Ratio
3.50:1.00
Minimum Interest Coverage Ratio
3.00:1.00
Compliance as of period end
In Compliance
6. FAIR VALUE MEASUREMENTS
Fair Value on Recurring Basis
The carrying values of cash and cash equivalents, receivables, net, and accounts payable are considered to be representative of their respective fair values due to the short-term nature of these instruments. We measure our contingent consideration liabilities related to business combinations at fair value. For more information see Note 13 – Business Combinations.
Fair Value on Non-Recurring Basis
Fair value measurements were applied to our long-term debt portfolio. We believe the carrying value of our term loan approximates the fair market value primarily due to the fact that the non-performance risk of servicing our debt obligations, as reflected in our business and credit risk profile, has not materially changed since we assumed our debt obligations under the Amended Credit Agreement. In addition, due to the floating-rate nature of our term loan, the market value is not subject to variability solely due to changes in the general level of interest rates as is the case with a fixed-rate debt obligation. Based on active market trades of our Senior Notes close to September 30, 2020 (Level 1 fair value measurement), we estimate that the fair value of the Senior Notes is approximately $417.0 million compared to a gross carrying value of $400.0 million at September 30, 2020.
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7. SEGMENT INFORMATION
The following tables set forth our net sales and operating results by segment, in thousands:
Net Sales
Operating Profit (b)
Our operations by segment were (a):
83,142
69,846
32,787
23,406
Intercompany eliminations
(6,374)
(5,935)
109,555
87,317
General corporate expense, net (c)
(8,032)
(6,872)
Operating profit, as reported
213,136
189,568
81,612
65,154
(18,169)
(18,013)
276,579
236,709
(24,610)
(23,606)
8. LEASES
We have operating leases for our installation branch locations, distribution centers, our Branch Support Center in Daytona Beach, Florida, vehicles and certain equipment. In addition, we lease certain operating facilities from certain related parties, primarily former owners (and in some cases, current management personnel) of companies acquired. These related party leases are immaterial to our unaudited condensed consolidated statements of operations.
We recognize a ROU asset and a lease liability at the lease commencement date. Our leases may include options to extend or terminate the lease, which will be reflected in the calculation of the lease liability and corresponding ROU asset when it is reasonably certain that we will exercise that option. In addition, certain vehicle lease agreements have residual value guarantees at the end of the lease term which require us to return the asset with a specified percentage of the original or other calculated value. We do not recognize ROU assets and lease liabilities for short-term leases that have an initial lease term of 12 months or less. We recognize the lease payments associated with short-term leases as an expense on a straight-line basis over the lease term.
15
The components of lease expense were as follows and are primarily included in cost of sales on the accompanying unaudited condensed consolidated statements of operations, in thousands:
Operating lease cost (a)
11,475
12,393
35,842
38,597
Short-term lease cost
3,209
3,381
9,086
9,391
Sublease income
(42)
(153)
(461)
Net lease cost
14,642
15,621
44,775
Future minimum lease payments under non-cancellable operating leases as of September 30, 2020 were as follows, in thousands:
Payments due by Period
10,234
32,978
22,083
12,429
7,135
2025 & Thereafter
7,189
Total future minimum lease payments
92,048
Less: imputed interest
(6,629)
Lease liability at September 30, 2020
85,419
As of September 30, 2020, the weighted average remaining lease term was 3.5 years and the related lease liability was calculated using a weighted average discount rate of 3.9%. The lease liability is initially measured as the present value of the unpaid lease payments as of the lease commencement date. The lease liability is discounted based on our IBR at the time of initial adoption of ASU 2016-02 for all existing leases or upon a modification to the lease term and at the time of lease commencement for all future leases.
The amount below is included in the cash flows provided by (used in) operating activities section on the accompanying unaudited condensed consolidated statements of cash flows, in thousands:
Cash paid for amounts included in the measurement of lease liabilities
(31,862)
(33,914)
9. INCOME TAXES
Our effective tax rates were 25.5 percent and 22.6 percent for the three and nine months ended September 30, 2020, respectively. The effective tax rates for the three and nine months ended September 30, 2019, were 23.2 percent and 22.0 percent, respectively. The higher 2020 tax rate for the three months ended September 30, 2020 was due to a smaller benefit related to share-based compensation, state filing position changes, and an unfavorable return to accrual adjustment.
A tax benefit of $0.8 million and $7.7 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 nine months ended September 30, 2020, respectively.
16
At September 30, 2020, the net deferred tax liability of $169.2 million consisted of net long-term deferred tax assets of $4.4 million and net long-term deferred tax liabilities of $173.6 million. The decrease in the net deferred tax liability was primarily related to the adoption of ASU 2016-13 and a return to accrual adjustment related to 2019 returns filed in 2020.
10. INCOME PER SHARE
Basic net income per share is calculated by dividing net income by the number of weighted average shares outstanding during the period, without consideration for common stock equivalents.
Diluted net income per share is calculated by adjusting the number of 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 net income per share were computed as follows:
Net income (in thousands) - basic and diluted
Weighted average number of common shares outstanding - basic
Dilutive effect of common stock equivalents:
RSAs with service-based conditions
42,317
82,087
53,719
86,373
RSAs with market-based conditions
159,985
195,740
145,835
183,537
RSAs with performance-based conditions
49,065
82,750
38,719
63,329
Stock options
111,526
216,468
138,017
230,932
Weighted average number of common shares outstanding - diluted
Basic net income per common share
Diluted net income per common share
The following table summarizes shares excluded from the calculation of diluted net income per share because their effect would have been anti-dilutive:
Anti-dilutive common stock equivalents:
4,184
5,264
2,780
6,567
26,556
12,642
39,998
72,580
Total anti-dilutive common stock equivalents
46,962
84,411
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11. SHARE-BASED COMPENSATION
Effective July 1, 2015, our eligible employees commenced participation 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 September 30, 2020, we had 2.1 million shares remaining available for issuance under the 2015 LTIP.
Share-based compensation expense is included in selling, general, and administrative expense. The income tax effect associated with share-based compensation awards is included in income tax expense. The following table presents share-based compensation amounts recognized in our condensed consolidated statements of operations, in thousands:
Share-based compensation expense
Income tax benefit realized
838
1,304
7,734
5,110
The following table presents a summary of our share-based compensation activity for the nine months ended September 30, 2020, in thousands, except per share amounts:
RSAs
Stock Options
Number of Shares
Weighted Average Grant Date Fair Value Per Share
Weighted Average Exercise Price Per Share
AggregateIntrinsicValue
Balance December 31, 2019
411.6
57.51
373.5
17.06
45.90
21,356.4
Granted
192.8
129.11
71.0
39.49
118.58
Converted/Exercised
(251.1)
43.44
(184.8)
14.84
39.54
13,222.1
Forfeited/Expired
(26.1)
90.81
(20.0)
30.13
87.67
Balance September 30, 2020
327.2
87.20
239.7
24.33
68.86
22,925.1
Exercisable September 30, 2020 (a)
63.8
18.89
51.04
7,638.0
Unrecognized share-based compensation expense related to unvested awards is shown in the following table, dollars in thousands:
Unrecognized Compensation Expense on Unvested Awards
Weighted AverageRemainingVesting Period
11,536
1.2 years
1,359
1.0 years
Total unrecognized compensation expense related to unvested awards
12,895
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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:
Payout Ranges and Related Expense
RSAs with Performance-Based Conditions
Grant Date Fair Value
0%
25%
100%
200%
February 19, 2018
1,865
466
3,730
February 18, 2019
2,281
570
4,562
February 17, 2020
2,716
679
5,432
During the first quarter of 2020, RSAs with performance-based conditions that were granted on February 21, 2017 vested based on cumulative three-year achievement of 200%. Total compensation expense recognized over the three-year performance period, net of forfeitures, was $3.3 million.
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 2020 and 2019:
Measurement period (in years)
2.88
2.87
Risk free interest rate
1.40
2.50
Dividend yield
0.00
Estimated fair value of market-based RSAs at grant date
158.24
80.74
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 stock options granted in 2020 and 2019:
1.53
2.59
Expected volatility, using historical return volatility and implied volatility
31.50
32.50
Expected life (in years)
6.0
Estimated fair value of stock options at grant date
21.16
12. SHARE REPURCHASE PROGRAM
On February 22, 2019, our Board authorized the 2019 Repurchase Program, pursuant to which the Company may purchase up to $200.0 million of our common stock. Share repurchases may be executed through various means including open market purchases, privately negotiated transactions, accelerated share repurchase transactions, or other available means. The 2019 Share Repurchase Program does not obligate the Company to purchase any shares and has no expiration date. Authorization for the 2019 Share Repurchase Program may be terminated, increased, or decreased by the Board at its discretion at any time. As of September 30, 2020, the Company has approximately $46.0 million remaining under the 2019 Repurchase Program.
Effective November 4, 2019, under the 2019 Repurchase program, we entered into the 2019 ASR Agreement. We paid BofA $50.0 million in exchange for an initial delivery of 392,501 shares of our common stock on November 5, 2019, representing an estimated 85% of the total number of shares we expected to receive under the 2019 ASR Agreement, at the time we entered into the agreement. During the quarter ended March 31, 2020, we received an additional 73,455 shares of our common stock from BofA representing the final settlement of the 2019 ASR agreement. We purchased a total of 465,956 shares of our common stock under the 2019 ASR Agreement at an average price per share of $107.31.
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Effective November 7, 2018, under the 2017 Repurchase Program, we entered into the 2018 ASR Agreement. We paid JPMorgan Chase Bank, N.A. $50.0 million in exchange for an initial delivery of 796,925 shares of our common stock on November 8, 2018, representing an estimated 85% of the total number of shares we expected to receive under the 2018 ASR Agreement, at the time we entered into the agreement. During the quarter ended March 31, 2019, we received an additional 176,327 shares of our common stock from JPMorgan Chase Bank, N.A., representing the final settlement of the 2018 ASR Agreement. We purchased a total of 973,252 shares of our common stock under the 2018 ASR Agreement at an average price per share of $51.37.
The following table sets forth our share repurchases under the 2019 and 2017 Repurchase Programs during the periods presented:
Number of shares repurchased
57,810
364,074
582,254 (a)
810,077 (b)
Share repurchase cost (in thousands)
8,997
32,677
43,149
52,177
(a) The nine months ended September 30, 2020 includes 73,455 shares we received as final settlement of our 2019 ASR Agreement.
(b) The nine months ended September 30, 2019 includes 176,327 shares we received as final settlement of our 2018 ASR Agreement.
13. BUSINESS COMBINATIONS
We continue to acquire businesses as part of our ongoing strategy to grow our company and expand our market share. Each acquisition has been accounted for as a business combination under ASC 805, “Business Combinations.” Acquisition related costs for the three months ended September 30, 2020, was $0.2 million. There were no acquisition related costs for the three months ended September 30, 2019. Acquisition related costs for the nine months ended September 30, 2020 and 2019, were $0.4 million and $0.1 million, respectively. Acquisition costs are included in selling, general, and administrative expense in our condensed consolidated statements of operations.
Acquisitions
On July 15, 2019, we acquired Viking, an insulation company located in Burbank, California. The purchase price of approximately $7.7 million was funded by cash on hand of $6.5 million and contingent consideration of $1.2 million.
On February 20, 2020, we acquired Cooper, a commercial glass company serving the Memphis market. The purchase price of approximately $11.5 million was funded by cash on hand of $10.5 million and contingent consideration of $1.0 million. We recognized goodwill of $5.7 million in connection with this acquisition during the nine months ended September 30, 2020.
On February 24, 2020, we acquired Hunter, a residential insulation company located in Long Island, New York. The purchase price of approximately $9.1 million was funded by cash on hand. We recognized goodwill of $5.3 million in connection with this acquisition during the nine months ended September 30, 2020.
Contingent Consideration
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. We made the final contingent payment of $0.8 million during the three months ended June 30, 2020 and have no remaining obligation under the arrangement.
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The acquisition of Viking included a contingent consideration arrangement that requires additional consideration to be paid by TopBuild based on the achievement of annual gross revenue targets over a three-year period. The range of undiscounted amounts TopBuild may be required to pay under the contingent consideration agreement is between zero and $1.5 million. The fair value of the contingent consideration recognized on the acquisition date of $1.2 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 10.0%. Changes in the fair value measurement each period reflect the passage of time as well as the impact of adjustments, if any, to the likelihood of achieving the specified targets. We made a contingent payment of $0.5 million in the three months ended September 30, 2020.
The acquisition of Cooper includes a contingent consideration arrangement that requires additional consideration to be paid by TopBuild based on the achievement of annual gross revenue targets over a two-year period. The range of undiscounted amounts TopBuild may be required to pay under the contingent consideration agreement is between zero and $1.0 million, which also represents the fair value recognized on the acquisition date.
The following table presents the fair value of contingent consideration, in thousands:
Date of Acquisition
February 27, 2017
July 15, 2019
February 20, 2020
Fair value of contingent consideration recognized at acquisition date
2,110
1,243
1,000
Contingent consideration at December 31, 2019
822
Change in fair value of contingent consideration during the nine months ended September 30, 2020
85
Payment of contingent consideration during the nine months ended September 30, 2020
(841)
(500)
Liability balance for contingent consideration at September 30, 2020
889
14. ACCRUED LIABILITIES
The following table sets forth the components of accrued liabilities, in thousands:
Accrued liabilities:
Salaries, wages, and commissions
39,908
32,154
Insurance liabilities
23,440
22,506
Interest payable on long-term debt
9,563
3,966
Other
27,728
23,653
Total accrued liabilities
See Note 3 – Revenue Recognition for discussion of our deferred revenue balances and related revenue recognition policy.
15. OTHER 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 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 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.
The following table summarizes our outstanding performance, licensing, insurance and other bonds, in thousands:
Outstanding bonds:
Performance bonds
102,403
87,286
Licensing, insurance, and other bonds
27,603
25,309
Total bonds
130,006
112,595
16. SUBSEQUENT EVENTS
On October 1, 2020, we acquired Garland, an insulation installation company, based in Texas. The acquisition was accounted for as a business combination under ASC 805, “Business Combinations.” The purchase price of approximately $62 million was funded by cash on hand. During the measurement period, we expect to receive additional detailed information to complete the purchase price allocation.
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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
TopBuild, headquartered in Daytona Beach, Florida, is a leading installer and distributor of insulation and other building products to the U.S. construction industry. We trade on the NYSE under the ticker symbol “BLD.”
We operate in two segments: Installation (TruTeam) and Distribution (Service Partners). Our Installation segment installs insulation and other building products nationwide through our TruTeam contractor services business which, as of September 30, 2020, had approximately 200 branches located across the United 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 gutters, glass and windows, afterpaint products, fireproofing, 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.
Our Distribution segment sells and distributes insulation and other building products, including gutters, fireplaces, closet shelving, and roofing materials through our Service Partners business, which, as of September 30, 2020, had approximately 75 branches located across the United 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 the availability of supply to our local branches and distribution centers at competitive prices with the overall effect of driving efficiencies through our supply chain. Second, being a leader in both installation and distribution allows us to effectively reach a broader range 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 7 – Segment Information to our unaudited condensed consolidated financial statements contained in Part I, Item 1 of this Quarterly Report, which is incorporated herein by reference. For additional details regarding our strategy, material trends in our business and seasonality, please refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report for the year ended December 31, 2019, as filed with the SEC on February 25, 2020, which discussion is hereby incorporated herein by reference.
COVID-19 BUSINESS UPDATE
We continue to monitor the COVID-19 pandemic and its impact on macroeconomic and local economic conditions. While we are currently able to operate in all of our locations, there is no guarantee that the services we provide will continue to be allowed or that other events making the provision of our services challenging or impossible, will not occur. For example, if there are surges in levels of COVID-19 infections in certain states, those states may respond by, among other things, deeming residential and commercial construction as nonessential in connection with a restriction of commercial activity.
We continue to implement procedures and processes as required or recommended by governmental and medical authorities to ensure the safety of our employees, including increasing our cleaning and sanitizing practices at all locations and for all company vehicles, mandating social distancing on job sites and within our branch operations and limiting all but essential travel. However, we are not able to predict whether our customers will continue to operate at their current or typical volumes, and such decreases in their operations would have a negative impact on our business. We are also unable to predict how long the COVID-19 pandemic will last and the impact of the pandemic on demand for our products and services. For additional discussion of the potential impact of the COVID-19 pandemic on our business, see the sections entitled “Outlook” and “Risk Factors” included in this Quarterly Report.
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 in this Quarterly Report.
THIRD QUARTER 2020 VERSUS THIRD QUARTER 2019
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:
Cost of sales ratio
71.6
73.7
Gross profit margin
28.4
26.3
Selling, general, and administrative expense to sales ratio
13.9
14.5
Operating profit margin
14.6
11.8
Net margin
10.0
8.1
Sales and Operations
Net sales increased 2.2 percent for the three months ended September 30, 2020, from the comparable period of 2019. The increase was primarily driven by a 1.1 percent increase in sales volume, a 0.7 percent increase in sales from our acquisitions and 0.4 percent increase due to higher selling prices.
Gross profit margins were 28.4 percent and 26.3 percent for the nine months ended September 30, 2020 and 2019, respectively. Gross profit margin improved primarily due to operational efficiencies, cost reduction initiatives, material deflation, and lower insurance costs.
Selling, general, and administrative expense, as a percent of sales, was 13.9 percent and 14.5 percent for the three months ended September 30, 2020 and 2019, respectively. The decrease in selling, general, and administrative expense as a percent of sales was primarily the result of reduced travel and entertainment activity, and savings from cost reduction activities.
Operating margins were 14.6 percent and 11.8 percent for the three months ended September 30, 2020 and 2019, respectively. The increase in operating margins was due to operational efficiencies, savings from cost reduction initiatives, material deflation, lower insurance costs, and reduced travel and entertainment activity.
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Business Segment Results
The following table sets forth our net sales and operating profit margins by business segment, in thousands:
Percent Change
Net sales by business segment:
(1.2)
10.5
2.2
Operating profit by business segment:
19.0
40.1
Operating profit before general corporate expense
25.5
General corporate expense, net
26.2
Operating profit margins:
16.9
14.0
13.4
10.6
Operating profit margin before general corporate expense
15.7
12.8
Sales
Sales in our Installation segment decreased $6.2 million, or 1.2 percent, for the three months ended September 30, 2020, as compared to the same period in 2019. The decrease was due to a 3.4 percent decrease in volume driven by the negative impacts of the COVID-19 pandemic primarily on our Commercial sales, partially offset by a 1.2 percent impact from higher selling prices and a 0.9 percent increase in sales from our acquisitions.
Operating margins
Operating margins in our Installation segment were 16.9 percent and 14.0 percent for the three months ended September 30, 2020 and 2019, respectively. The increase in operating margins was driven by operational efficiencies, savings from cost reduction initiatives, material deflation, lower insurance costs, and reduced travel and entertainment activity.
Sales in our Distribution segment increased $23.2 million, or 10.5 percent, for the three months ended September 30, 2020, as compared to the same period in 2019. This increase was due to a 12.2 percent increase in volume partially offset by a 1.7 percent impact from lower selling prices.
Operating margins in our Distribution segment were 13.4 percent and 10.6 percent for the three months ended September 30, 2020 and 2019, respectively. The increase in operating margins was driven by higher sales, operational efficiencies, savings from cost reduction initiatives, material deflation, and reduced travel and entertainment activity.
OTHER ITEMS
Other expense, net, which primarily consisted of interest expense, was $7.6 million and $8.9 million for the three months ended September 30, 2020 and 2019, respectively. The decrease was primarily driven by lower LIBOR rates and a lower balance due on our term loan.
Income tax expense was $23.9 million, an effective tax rate of 25.5 percent, for the three months ended September 30, 2020, compared to $16.6 million, an effective tax rate of 23.2 percent, for the comparable period in 2019. The tax rate for the three months ended September 30, 2020 was higher due to a smaller benefit related to share-based compensation, state filing position changes, and an unfavorable return to accrual adjustment.
FIRST NINE MONTHS 2020 VERSUS FIRST NINE MONTHS 2019
72.5
74.0
27.5
26.0
14.8
15.1
12.6
10.9
8.8
7.4
Net sales increased 1.8 percent for the nine months ended September 30, 2020, from the comparable period of 2019. The increase was primarily driven by a 0.9 percent impact from higher selling prices and a 0.8 percent increase in sales from our acquisitions, with nearly flat volumes due to the negative impacts of COVID-19 on business activity.
Gross profit margins were 27.5 percent and 26.0 percent for the nine months ended September 30, 2020 and 2019, respectively. Gross profit margin improved primarily due to higher selling prices, operational efficiencies and savings from cost reduction initiatives, partially offset by higher depreciation expense.
Selling, general, and administrative expense, as a percent of sales, was 14.8 percent and 15.1 percent for the nine months ended September 30, 2020 and 2019, respectively. Decreased selling, general, and administrative expense as a percent of sales was primarily the result of higher sales, savings from cost reduction initiatives, and reduced travel and entertainment activity.
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Operating margins were 12.6 percent and 10.9 percent for the nine months ended September 30, 2020 and 2019, respectively. The increase in operating margins was due to higher selling prices, operational efficiencies, savings from cost reduction initiatives and reduced travel and entertainment activity, partially offset by higher depreciation expense.
0.3
5.6
1.8
12.4
25.3
16.8
18.2
14.9
13.2
12.1
10.2
Sales in our Installation segment increased $3.8 million, or 0.3 percent, for the nine months ended September 30, 2020, as compared to the same period in 2019. The increase in sales was driven by a 1.3 percent impact from higher selling prices and 1.1 percent due to sales from our acquisitions, partially offset by a 2.2 percent decrease in volume driven by the negative impact of COVID-19 on business activity.
Operating margins in our Installation segment were 14.9 percent and 13.2 percent for the nine months ended September 30, 2020 and 2019, respectively. The increase in operating margins was driven by operational efficiencies, higher selling prices, cost reduction initiatives, and reduced travel and entertainment activity, partially offset by higher depreciation.
Sales in our Distribution segment increased $35.8 million, or 5.6 percent, for the nine months ended September 30, 2020, as compared to the same period in 2019. The increase in sales was due to a 6.0 percent increase in volume despite a negative impact from COVID-19 on business activity, partially offset by a 0.4 percent negative impact from lower selling prices.
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Operating margins in our Distribution segment were 12.1 percent and 10.2 percent for the nine months ended September 30, 2020 and 2019, respectively. The increase in operating margins was driven by operational efficiencies, savings from cost reduction initiatives and reduced travel and entertainment activity, partially offset by higher depreciation.
Other expense, net, which primarily consisted of interest expense, was $24.3 million and $27.2 million for the nine months ended September 30, 2020 and 2019, respectively. The decrease was primarily driven by lower LIBOR rates and a lower balance due on our term loan.
Income tax expense was $51.4 million, an effective tax rate of 22.6 percent, for the nine months ended September 30, 2020, compared to $40.9 million, an effective tax rate of 22.0 percent, for the comparable period in 2019. The tax rate for the nine months ended September 30, 2020 was higher due to state filing position changes and an unfavorable return to accrual adjustment, partially offset by a larger benefit related to share-based compensation.
Cash Flows and Liquidity
Significant sources (uses) of cash and cash equivalents are summarized for the periods indicated, in thousands:
Changes in cash and cash equivalents:
Net cash flows provided by operating activities increased $72.9 million for the nine months ended September 30, 2020, as compared to the prior year period. The change was primarily due to the timing of accounts receivable collections and accrued liability payments, as well as an increase in net income.
Net cash used in investing activities was $46.3 million for the nine months ended September 30, 2020, primarily composed of $27.2 million for purchases of property and equipment, primarily vehicles, and $21.5 million for acquisitions, partially offset by $2.3 million in proceeds from the sale of property and equipment. Net cash used in investing activities was $38.3 million for the nine months ended September 30, 2019, primarily composed of $34.1 million for purchases of property and equipment, primarily vehicles, and $6.5 million for the acquisition of Viking, partially offset by $2.2 million in proceeds from the sale of property and equipment.
Net cash used in financing activities was $78.9 million for the nine months ended September 30, 2020. During the nine months ended September 30, 2020, we used $43.1 million for the repurchase of common stock pursuant to the 2019 Repurchase Program, $19.2 million for payments on our term loan under our Amended Credit Agreement and on our equipment notes, $14.8 million on purchases of common stock for tax withholding obligations related to the vesting and exercise of share-based incentive awards, and $2.3 million in debt issuance costs as a result of entering into a new term loan and revolving credit facility. Net cash used in financing activities was $73.8 million for the nine months ended September 30, 2019. During the nine months ended September 30, 2019, we used $52.2 million for the repurchase of common stock pursuant to the 2019 Repurchase Program, $19.4 million for payments on our term loan under our Amended Credit Agreement and on our equipment notes, and $11.1 million on purchases of common stock for tax withholding obligations related to the vesting and exercise of share-based incentive awards. We also made payments totaling $1.1 million for contingent consideration for EcoFoam and Santa Rosa. We received $10.0 million in proceeds from the issuance of equipment notes.
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We are closely managing our balance sheet, including maximizing our cash flow, to maintain our strong foundation and provide stability as we continue to work through the impacts of the COVID-19 pandemic. We had solid liquidity available to us at September 30, 2020, with $315.3 million of cash and $389.6 million available borrowing capacity under our Revolving Facility. In the three months ended September 30, 2020, we resumed share repurchases under the 2019 Share Repurchase Program, as well as reengaged with companies previously in our acquisition pipeline. Both activities had been previously suspended due to the uncertainty caused by the COVID-19 pandemic. 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 working capital needs.
The following table summarizes our liquidity, in thousands:
Cash and cash equivalents (a)
Total liquidity
704,956
373,425
(a) Our cash and cash equivalents consist of AAA-rated money market funds as well as cash held in our demand deposit accounts.
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. Information regarding our outstanding bonds as of September 30, 2020 is incorporated by reference from Note 15 – Other Commitments and Contingencies to our unaudited condensed consolidated financial statements contained in Part I, Item 1 of this Quarterly Report.
OUTLOOK
Throughout the COVID-19 pandemic, construction activities were generally deemed an essential service in all but a few states, resulting in our ability to continue operating in most locations until segments of the economy started to reopen during the second quarter. Management continues to evaluate every aspect of our business and is monitoring ongoing developments which may trigger restrictions on operating activities, an economic downturn, or other adverse impact to our business resulting from the pandemic’s greater economic impact.
OFF-BALANCE SHEET ARRANGEMENTS
We had no material off-balance sheet arrangements during the quarter ended September 30, 2020, other than short-term leases, letters of credit, and performance and license bonds, which have been disclosed in Part 1, Item 1 of this Quarterly report.
CONTRACTUAL OBLIGATIONS
There have been no material changes to our contractual obligations from those previously disclosed in our Annual Report for the year ended December 31, 2019, as filed with the SEC on February 25, 2020, except for the amendment to our Original Credit Agreement on March 20, 2020. See further information as disclosed in Note 5 – Long Term Debt in our unaudited condensed consolidated financial statements contained in Part 1, Item 1 of this Quarterly Report.
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CRITICAL ACCOUNTING POLICIES
We prepare our condensed 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 critical accounting policies have not changed from those previously reported in our Annual Report for year ended December 31, 2019, as filed with the SEC on February 25, 2020, except as required by the adoption of ASU 2016-13. See further information as disclosed in Note 2 – Accounting Policies in our unaudited condensed consolidated financial statements contained in Part 1, Item 1 of this Quarterly Report.
APPLICATION OF NEW ACCOUNTING STANDARDS
Information regarding application of new accounting standards is incorporated by reference from Note 2 – Accounting Policies to our unaudited condensed consolidated financial statements contained in Part I, Item 1 of this Quarterly Report.
FORWARD-LOOKING STATEMENTS
Statements contained in this report that reflect our views about future periods, including our future plans and performance, constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as “will,” “would,” “anticipate,” “expect,” “believe,” “designed,” “plan,” or “intend,” the negative of these terms, and similar references to future periods. These views involve risks and uncertainties that are difficult to predict and, accordingly, our actual results may differ materially from the results discussed in our forward-looking statements. We caution you against unduly relying on any of these forward-looking statements. Our future performance may be affected by the duration and impact of the COVID-19 pandemic on the United States economy, specifically with respect to residential and commercial construction, our ability to continue operations in markets affected by the COVID-19 pandemic and our ability to collect receivables from our customers, our reliance on residential new construction, residential repair/remodel, and commercial construction, our reliance on third-party suppliers and manufacturers, our ability to attract, develop, and retain talented personnel and our sales and labor force, our ability to maintain consistent practices across our locations, and our ability to maintain our competitive position. We discuss the material risks we face under the caption entitled “Risk Factors” in our Annual Report for the year ended December 31, 2019, as filed with the SEC on February 25, 2020, as well as under the caption entitled “Risk Factors” in subsequent reports that we file with the SEC. Our forward-looking statements in this filing speak only as of the date of this filing. Factors or events that could cause our actual results to differ may emerge from time to time and it is not possible for us to predict all of them. Unless required by law, we undertake no obligation to update publicly any forward-looking statements as a result of new information, future events, or otherwise.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
On March 20, 2020, the Company entered into the Amended Credit Agreement, which renews, amends and restates the Original Credit Agreement. The Amended Credit Agreement consists of a senior secured term loan facility in the amount of $300.0 million and the Revolving Facility in the amount of $450.0 million. We also have outstanding Senior Notes with an aggregate principal balance of $400.0 million. The Senior Notes bear a fixed rate of interest and therefore are excluded from the calculation below as they are not subject to fluctuations in interest rates.
Interest payable on both the term loan facility and Revolving Facility under the Amended Credit Agreement is based on a variable interest rate. As a result, we are exposed to market risks related to fluctuations in interest rates on this outstanding indebtedness. As of September 30, 2020, we had $292.5 million outstanding under our term loan facility, and the applicable interest rate as of such date was 1.50%. Based on our outstanding borrowings under the Amended Credit Agreement as of September 30, 2020, a 100 basis point increase in the interest rate would result in a $2.8 million increase in our annualized interest expense. There was no outstanding balance under the Revolving Facility as of September 30, 2020.
Item 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Quarterly Report, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2020.
Changes in Internal Control over Financial Reporting
There was no change in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) in the most recent fiscal quarter ended September 30, 2020, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II – OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The information set forth under the caption “Litigation” in Note 15 – Other Commitments and Contingencies to our unaudited condensed consolidated financial statements contained in Part I, Item 1 of this Quarterly Report, is incorporated by reference herein.
Item 1A. RISK FACTORS
There have been no material changes to our risk factors as previously disclosed in our Annual Report for the year ended December 31, 2019, as filed with the SEC on February 25, 2020, and supplemented in our Quarterly Report for the three months ended March 31, 2020, as filed with the SEC on May 5, 2020, which are incorporated by reference herein.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table provides information regarding the repurchase of our common stock for the three months ended September 30, 2020, in thousands, except share and per share data:
Period
Total Number of Shares Purchased
Average Price Paid per Common Share
Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
July 1, 2020 - July 31, 2020
-
54,962
August 1, 2020 - August 31, 2020
24,524
152.87
51,213
September 1, 2020 - September 30, 2020
33,286
157.67
45,965
155.63
All repurchases were made using cash resources. Excluded from this disclosure are shares repurchased to settle statutory employee tax withholding related to the vesting of stock awards.
Item 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
Item 4. MINE SAFETY DISCLOSURES
Item 5. OTHER INFORMATION
Item 6. EXHIBITS
The Exhibits listed on the accompanying Index to Exhibits are filed or furnished (as noted on such Index) as part of this Quarterly Report and incorporated herein by reference.
INDEX TO EXHIBITS
Incorporated by Reference
Filed
Exhibit No.
Exhibit Title
Form
Exhibit
Filing Date
Herewith
31.1
Principal Executive Officer Certification required by Rules 13a-14 and 15d-14 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
X
31.2
Principal Financial Officer Certification required by Rules 13a-14 and 15d-14 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1‡
Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002
32.2‡
Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of Sarbanes-Oxley Act of 2002
101.INS
Inline XBRL Instance Document - the Instance Document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
101.SCH
Inline XBRL Taxonomy Extension Schema Document
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
104
Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
‡Furnished herewith
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
By:
/s/ John S. Peterson
Name:
John S. Peterson
Title:
Vice President and Chief Financial Officer
(Principal Financial Officer)
November 3, 2020