TopBuild Corp Q2 FY2023 Earnings Call

Greetings, and welcome to the TopBuild Second Quarter Earnings Conference Call. This conference is being recorded. It is now my pleasure to introduce your host, Miss Tabitha Zane, Vice President of Investor Relations. Thank you, Miss Zane. You may begin.

Thank you, and good morning. On the call today are Robert Buck, President and Chief Executive Officer; and Rob Kuhns, Chief Financial Officer. We have posted senior management’s formal remarks and a PowerPoint presentation that summarizes our comments on our website at topbuild.com. Many of our remarks will include forward-looking statements which are subject to known and unknown risks and uncertainties, including those set forth in this morning’s press release as well as in the company’s filings with the SEC. The company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events. Please note that some of the financial measures to be discussed on this call will be on a non-GAAP basis. The non-GAAP measures are not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. We have provided a reconciliation of these financial measures to the most comparable GAAP measures in a table included in today’s press release and in our second quarter presentation which can also be found on our website. I will now turn the call over to Robert Buck.

Good morning, and thank you for joining us today. 2023 is shaping up to be a solid year for TopBuild. We continue to operate in a favorable environment and remain focused on driving profitable growth, a cornerstone of our operating model. The volume growth and strong margin expansion we’ve achieved, not only this year but also over the past eight years since becoming a publicly traded company, is a testament to our entire TopBuild team and our continuing emphasis on operational excellence and driving improvements throughout all areas of our business. Also on display is the strength of our diversified model which affords us multiple avenues for growth and gives us the ability to outperform in any environment. Total sales for the first six months are up almost 6%. Our gross margin expanded 140 basis points to 30.7%, and our adjusted EBITDA margin grew 170 basis points to 19.9%. We are increasingly optimistic about how the rest of the year will unfold, based in part on recent positive commentary from our builder customers, single-family starts data over the past two months and our continued strong commercial performance. This improved outlook is reflected in our full year guidance for 2023, which Rob will discuss in further detail. Reviewing our second quarter results, a positive mix of installation business kept our branches busy. While we did see some slowdown in single-family work, we definitely outperformed the single-family market. We also demonstrated the strength of our operating model with outstanding multifamily and commercial execution. Our new Lead App continues to identify commercial opportunities, and our installation branch managers are aggressively pursuing these projects. Their focus resulted in a 22.6% increase in commercial revenue this quarter. On the heavy commercial front, we continue to drive improvements throughout this business, which has enhanced our win rate for many projects across the country. Our installation crews are working on a wide range of projects, including the Nashville International Airport, the UCI Medical Center in Irvine, California, and the revitalization of Two Penn Plaza in New York. We are agnostic as to the types of projects on which we work and are not over-indexed to office or any other type of heavy commercial work. Looking ahead, our commercial backlog remains robust, and we’re bidding jobs into late 2024 and early 2025. Turning to our Specialty Distribution business. Overall sales in the second quarter declined 2.3%, primarily as a result of our smaller contractor customers continuing to reduce inventory and as more construction activity has shifted to multifamily. We did see a 2.1% increase in sales from our commercial and industrial channels. Coming out of allocation, as residential distribution volumes continue to normalize, our teams are doing a nice job of identifying and building attractive new areas of growth as our overall results clearly demonstrate. Our Specialty Distribution teams are supporting a number of major industrial manufacturing projects, including two large chemical plants for Chevron. We’re also seeing quite a few major projects being planned across several diverse industries, fueling the demand for mechanical insulation. Maintenance and repair work on many commercial and industrial sites is also being scheduled, and this recurring revenue stream should serve as a continued stabilizing revenue driver for our Specialty Distribution business. We remain very optimistic about the opportunities for growth in both the commercial and industrial end markets in the U.S. and Canada. To touch briefly on labor and materials, labor remains tight. While fiberglass is no longer an allocation, some supply is still constrained. And no new capacity is expected until the second quarter of next year. Our M&A team has also been busy this year. To date, we’ve closed three residential insulation acquisitions, which combined are expected to contribute approximately $170 million of annual revenue. These are SRI Holdings, which enhances our presence in Georgia, Michigan, Ohio, Florida, Alabama, and South Carolina; Best Insulation, which serves high-growth regions in the Southeast and Southwest, including Florida, Texas, and Arizona; and Rocky Mountain Spray Foam, operating in Colorado. We were also excited to announce our planned acquisition of SPI last week. This highly strategic core transaction will bring together two specialty distributors of mechanical insulation; reinforce our position as a leading specialty distributor in the highly fragmented $17.5 billion insulation industry; further differentiate our unique operating model; and reduce the cyclicality of our business by increasing the percentage of recurring revenue driven by maintenance and repair work. As a reminder, this is an all-cash transaction valued at $960 million, and we expect to achieve between $35 million and $40 million of run rate cost synergies by the end of year two, post-close. Looking ahead, acquisitions will continue to be our number one capital allocation priority and a key component of our growth strategy, and our pipeline is filled with outstanding potential partners. In summary, we had a great second quarter and as you can see from our revised guidance, we are on track to have another strong year. Our team continues to execute well, and our diversified model positions TopBuild to outperform in any environment. Rob?

Thanks, Robert, and good morning, everyone. We had a great second quarter on both the top and bottom line, reflecting the strength of our unique model. Our teams continue to execute well with a relentless focus on driving operational improvements every day. This passion for constant improvement is core to our strategy and has been a key driver behind our continued success. Moving to the financials. I’ll start with an overview of our second quarter results, update you on our balance sheet, and provide the latest on our full year guidance. Second quarter net sales increased 3.4% to $1.3 billion, reflecting the success of our teams leveraging our multiple avenues for growth. Gross margin improved 190 basis points to 32%, the highest in the company’s eight-year history as a public company. This margin expansion reflects, in large part, our success in managing labor and material costs in this favorable operating environment and our continued focus on driving operational efficiencies and acquisition-related synergies. Second quarter adjusted EBITDA increased 13.7% to $275.5 million, and our adjusted EBITDA margin was 20.9%, a 190 basis point improvement compared to last year, driven by the gross margin expansion described earlier. Our Installation Segment’s second quarter net sales were $809.1 million, an increase of 8%. Our Installation teams did a great job pivoting to multifamily and commercial work, the latter of which increased by 22.6%, as single-family construction slowed slightly. Second quarter adjusted EBITDA margin for our Installation segment was 23.4%, a 260 basis point improvement. Our Specialty Distribution segment’s net sales declined 2.3% to $574.5 million. This was driven by the residential shift from single-family to multifamily, our contractor customers continuing to right-size their inventories, and distribution volumes normalizing post-allocation. Adjusted EBITDA for our Specialty Distribution segment was 17.6%, a 40 basis point improvement. Overall, solid results for this segment in the current environment. Interest expense in the second quarter increased from $13.4 million to $18.6 million, primarily as a result of higher interest costs on our variable rate term loan. Second quarter adjustments to net income were $2.1 million, driven by acquisition-related costs. Second quarter adjusted net earnings per diluted share were $5.25, an increase of 18.5% from the prior year. Moving to our balance sheet and cash flows. Our June 30 year-to-date operating cash flow was $385.8 million, compared to $217.7 million last year, a 77% increase driven by increased earnings and improvement in our working capital management. Working capital at the end of June improved to 14.9%. Our long-term working capital target remains at 12% to 14%, and our goal is to be within this range by year-end. On the capital allocation front, year-to-date CapEx was $30.7 million, approximately 1.2% of revenue and slightly below our long-term guidance. Through the end of the second quarter, we have allocated $46 million to M&A. M&A remains our number one capital allocation priority, as evidenced by our recent announcements for Best Insulation and SPI. There were no significant changes to our debt structure as our outstanding short-term and long-term debt balances remained just under $1.5 billion, with our average cost of debt at 4.77%. We ended the second quarter with net debt leverage of 0.92 times trailing 12 months adjusted EBITDA. This is down from 1.31 times at the end of 2022. Total liquidity at June 30, 2023, was $958.8 million, including cash of $526.3 million and an accessible revolver of $432.5 million. Before discussing our outlook for the remainder of 2023, I want to again express our enthusiasm for the acquisition of SPI. We are confident this transaction is a great use of capital and will create significant shareholder value. As a reminder, we plan to fund this $960 million deal with cash on hand and a $550 million delayed draw term loan. Following the close of this transaction and inclusive of Best Insulation, our pro forma net debt leverage would be 1.8 times as of June 30, 2023. This is well within our targeted leverage range between one and two times trailing 12 months adjusted EBITDA. Moving to our annual guidance. Based on our first half performance and our outlook for the remainder of the year, we expect 2023 to be another great year for TopBuild. Despite the slowdown in single-family starts in the first half of the year, we are more optimistic for residential today given the recent improvement in starts and the continuing strength of multifamily. As a result, we are raising our outlook and now expect residential revenue to be down only low single digits. Turning to our commercial and industrial business. Given our strong results, we are also more optimistic now and expect revenue to be up mid-single digits. This will put our full year sales in the range of $5.025 billion to $5.175 billion, a $325 million increase on the low end of the range and a $275 million increase on the high end. We also raised our guidance for adjusted EBITDA to be between $950 million and $1 billion, a $130 million increase on the low end of the range and a $90 million increase on the high end. Our long-range modeling targets are unchanged from those we published on May 4. As a reminder, we do not include the impact of any planned acquisitions in our outlook. I will now turn the call back to Robert for closing remarks.

To conclude, our team manages the business with a constant mindset of driving improvements and achieving operational excellence. We are proud of our track record of consistently producing strong financial results and we recognize our success is the result of having the best and most talented operators in the field and a dedicated and experienced group at our branch support center in Daytona Beach. Our goal is to create sustainable shareholder value in every operating environment. We are also very excited about the planned growth of our Specialty Distribution business through the acquisition of SPI. This is another transformative acquisition for our Company and one that will create long-term value for our shareholders. As always, I thank the entire TopBuild team for their focus on working safely to deliver value, quality, and service to our customers. Our highly engaged team is the reason TopBuild has been chosen a Best Places to Work company. Operator, we are now ready for questions.

Thank you. Our first question comes from Mr. Ken Zener with Seaport Research Partners. Please go ahead with your question.

Good morning everyone. I have two questions. First, I'd like to know about the installation units this quarter, which performed well. Can you provide insights on the single-family, multifamily, and commercial segments? I'm asking because I'm trying to grasp both the current quarter results and how we might see trends in the second half, especially in relation to the starts. That's my first question.

Okay. Ken, this is Rob. So breaking that down a little bit for you. We don’t break out single-family versus multifamily. But what I can tell you on the install side is our residential sales were up about 3% in the quarter. Single-family was down slightly as we’ve seen the impact of the slowdown in starts that we saw in the back half of last year going into the start of this year. But as we’ve been telling folks, our teams have been out ahead of that, bidding multifamily, bidding light commercial work. And we had a great quarter with that, right? So evidence of our multiple avenues for growth there and that we were able to grow residential even with single-family down. And then on the commercial side of things for install, we were up around 23% for the quarter. So a great growth story there.

Does that mean that if you didn’t contract as much in single-family, the recovery won’t be as strong? When considering the percentage declines in residential, such as going down 20% before rebounding, would that suggest your growth may also be more moderate?

Ken, this is Robert. So we would say, if you look at what happened in residential, second quarter, there’s probably a pretty good chance it reached the trough there relative to volumes and stuff. I think one thing, if you look at our single-family and multifamily performance combined, as we look at it individually, we’d say nice share gain by our teams in the field on residential. And you got to look at that commercial growth, it’s pretty phenomenal. It’s what the team delivered there as well. So I don’t think it mutes anything relative to the back half of what’s coming from a TopBuild perspective.

Excellent. Regarding the SPI deal, which is quite impressive, I don't think these questions were addressed during last week's call. This clearly reflects your distinct vision that continues to develop. When I was visiting and you hosted Distribution International, much of the material seemed similar to what would be used in residential projects, which relates to purchasing power. I assume the cost synergies of $35 million to $40 million will unfold similarly to DI, with around 40% material, if my memory serves me correctly. If that is the case, how significant is it for you to purchase more from the same manufacturers in relation to your returns and your capacity to gain even more market share?

Yes, Ken. This is Rob. I’ll begin, and I'm sure Robert will have more to add. When we acquired DI, we mentioned that one of the aspects we were excited about was the potential for growth and the opportunities for mergers and acquisitions in that space. At the top of our priority list was SPI. We're very pleased to have secured that acquisition. From a synergy perspective, the synergies are quite similar to what we experienced with DI. The categories will be roughly 50% related to the supply chain and 50% focused on operational improvements. As you’ve noticed, we exceeded the high end of that range with the DI transaction, contributing to the significant margin expansion we observed in Specialty Distribution this quarter, driven by the realization of those synergies. This is why we are so excited about the SPI acquisition.

Yes, I’d like to add to that, Ken. When we consider acquisitions and our history in this area, we have consistently mentioned synergies, particularly in supply chain. However, an important aspect is our dedicated integration team and our track record of delivering results that surpass these synergies. This success is based on a few key elements in our approach. One important factor is our ongoing commitment to operational improvements, including during acquisitions. We are acquiring strong brand companies, which allows us to integrate their insights back into the larger TopBuild business while also enhancing their operations. This has been crucial in helping us exceed expected synergies. While we may not always highlight this, it has significantly contributed to our overachievement in past acquisitions and in realizing synergies, and I want to emphasize this point here as well.

I assume it changes your discussion on the commercial side, especially with so many distribution points. During your Investor Day, you mentioned your capability to allocate labor on that specialty side. Have you reached that maximum or threshold, or are you truly able to serve commercial customers in a unique way?

Yes, we definitely believe that. I mentioned in my prepared remarks the work the team is doing in the field to drive improvements in that business, which we think is enhancing our win rate and overall performance. Our service perspective is very strong, particularly in installation and in our service partnerships for distribution. Now that we have the whole model of SPI and DI combined, which focuses on commercial and industrial distribution, we are leveraging businesses that are known for their service. This significantly aids our growth and helps us gain market share.

Thank you very much.

And our next question comes from the line of Mr. Stephen Kim with Evercore. Please proceed with your question.

Thank you very much. It was a great quarter. My first question is more focused on the overall industry. Can you share your expectations regarding housing starts for both single-family and multi-family units? Additionally, what is your outlook on fiberglass price increases? It seems there is growing optimism about another industry price increase for fiberglass as single-family housing rebounds. Do you agree that there is support for a price increase as we approach fall, or do you think the expected decline in multifamily activity and the recent rate spike might prevent such an announcement? Thank you.

Yes, Stephen, this is Rob. I’ll start off on the single-family, multifamily assumptions, and then Robert will add in on the supplier side of things. But from a guidance perspective, kind of the way we’re seeing the rest of the year play out, we expect the strength we’ve recently seen on single-family to continue. And so that’s what we’ve got baked into our guidance. So a starts number for the full year, somewhere between 1.4 million and 1.5 million, probably towards the upper end of that is probably what we’re expecting to see there. Obviously, the next few months will be key in terms of starts, in terms of what drives our fourth quarter results. And then multifamily, like we’ve been saying, the backlog remains really strong there. We’re still seeing good bidding activity there as well. So we feel really good about multifamily heading through the rest of the year as well.

Yes. This is Robert discussing fiberglass, building on Rob’s point about single-family. As single-family continues, we've done well updating our guidance and looking ahead. We believe single-family starts are on track, and there’s potential for upside in our guidance, which is encouraging. Regarding fiberglass, its performance will depend on single-family starts in the coming months. If the trend continues, we might see an increase in the fall. We need to observe the next few months closely. It's important to note that no increased capacity will be available until the second quarter of next year, so we will watch how those starts evolve, as they may influence manufacturers' decisions.

Okay, that's helpful. If we could shift our focus to the commercial and industrial segment, could you share how the residential performance compared to commercial and industrial within your Specialty Distribution sales? Additionally, could you provide insights into the pricing environment for C&I, particularly regarding foam, glass, and materials like calcium and silicon? We tend to concentrate on fiberglass, so any information you can share would be appreciated.

Yes. Yes, I’ll start off with the resi, C&I split. Robert will add on there on the price side. From a Specialty Distribution side of things, we did see things. On the Service Partners side, they’re serving a lot of the smaller contractors that have been impacted by the slowdown on the single-family side of things. So our residential sales were down around 8% in the quarter for Specialty Distribution. But we did see a nice second quarter in a row, growth on the commercial and industrial side. So sales up 2% on that side and up 5% year-to-date.

Yes. And I think building on that, Stephen. So I think whenever we look at those Specialty Distribution volumes on the residential side, we’re pretty. I think the team is doing a nice job. If you look at that compared to other industry data points out there, you can see how the Specialty Distribution team really has been performing well. I think relative to your pricing question on C&I, I’d say definitely stability there. If you remember, there wasn’t as much inflation coming in there. We keep talking about big projects coming on, whether it be MRO projects and some other larger projects coming. So if we think about the C&I side, definitely more sustainable or a nice job at sustaining price relative to the C&I piece of the business.

Okay, great. That’s very helpful, thanks guys.

Thank you. And our next question comes from the line of Mr. Joe Ahlersmeyer with Deutsche Bank. Please proceed with your question.

Hey good morning everybody and congrats on the results and updated guidance.

Thanks, Joe.

Just thinking about what seems to be some growing visibility, certainly into the back half, but even into next year. Good leading indicators on commercial, long multifamily backlogs and sort of calling a bottom here, it sounds like, on single-family in the second quarter. Maybe just at this point, assuming things don’t unexpectedly get significantly worse, are you sort of willing to target organic EBITDA growth in the next year? I know that you’ve got the deal coming through, which will help. But organically, should we expect EBITDA growth in 2024 at this point?

Yes, Joe. As you know, we haven’t given any guidance into 2024. But certainly, what we’re seeing with the leading indicators like you talked about, we’re certainly optimistic for 2024 and what we’re seeing, and we look to continue the trend we’ve had. If you look at the midpoint of our guidance we just put out, this will now be our eighth straight year of revenue growth and EBITDA expansion, and we’ll be looking to do that into 2024 as well.

Appreciate that. And maybe are there any call outs because the top line certainly seems to be the more constructive part of that conversation. But your gross margins are up, call it, 400 basis points run rate versus pre-pandemic. Is there any sort of watch out there on that line item? Maybe where if we’ve got 100 or 200 basis points or something, that needs to roll out? Or would you say that’s not the case?

Yes. I think certainly in the second quarter, right, there’s a lot of variables that go into our gross margin, right? If you think about it, you got the mix of the segments, which obviously is installs up more, that helps out there. You got all the variables that go into these large projects on the commercial side, both on distribution and residential. You got bidding, you got how available material is, you got labor availability, labor efficiency on the install side. We do a great job of managing that. Our ERP certainly gives us an advantage in managing that. But I’d say we even surprised ourselves in the second quarter with how good a job we did in managing that. And certainly, we did not bake all of that into our guidance for the back half of this year.

And I think it's Robert. As we always mention in our prepared remarks, and during our one-on-one discussions, we maintain a strong focus on operational improvements within the business. While the environment is favorable, the team continues to work on ideas and enhancements, particularly in terms of bottom quartile performance. It’s important to discuss the progress made over the past few years, and we certainly don’t want to overlook the operational improvements that have contributed to the business, in addition to the positive points Rob highlighted.

Congrats on the first half and good luck in the second.

Thanks, Joe.

Thank you. And our next question comes from the line of Mr. Jeffrey Stevenson with Loop Capital Markets. Please proceed with your question.

Certainly thanks for taking my questions and congrats on a strong quarter. So you reported a record quarter of gross margin, which was great to see. But moving forward, I was hoping you could provide a little more color on how you’re thinking about the cadence of gross margin given an expected moderating year-over-year inflation.

Yes, Jeff, this is Rob. As you know, we don’t provide that level of guidance. However, as I mentioned earlier, we did experience some benefits in Q2 that we aim to continue into Q3 and Q4. Is there a $10 million or 80 basis point benefit that we haven’t included in our forecasts for the second half? Absolutely. That’s how I see it as we move forward.

Okay. Understood. And you cited kind of continued destocking at the smaller contractor level and Specialty Distribution. And is that largely complete? Or do you think any of that will spill over into the third quarter? And also, your inventory is a bit lower sequentially, and just wondering if you’ve made any adjustments on the installation side as well, as we’re kind of moving into a period of slowing single-family residential demand?

Hi Jeff, this is Robert. On the Specialty Distribution side, we are seeing a normalization of distribution volumes following the allocation period. Many distributors turned to us during allocation, so it's natural to see this adjustment. Additionally, companies including ours are continuing to reduce their inventories, which is reflected in our results. The Specialty Distribution team effectively mitigated some of these challenges with other growth areas. Regarding installation, our teams are successfully managing inventory levels as materials have become available post-allocation, and they are focused on this at the local level for our installation business.

Got it. Thank you.

Thank you. And our next question comes from the line of Mr. Adam Baumgarten with Zelman & Associates. Please proceed with your question.

Hey good morning everyone. Just looking at the updated revenue guidance, I believe it implies some modest revenue declines in the back half. I’m just curious why that would be the case given improving single-family trends, easier comps. Just maybe if you could walk through the kind of kinks there.

Excuse me, everyone, sorry for the technical difficulties. Please hold on. Thank you for your patience. Adam, please go ahead with your question.

Okay, thanks yes good morning. Just looking at the updated revenue guidance, it implies at the midpoint, at least a modest revenue decline in the second half of 2023 year-over-year. I’m just curious why that would be the case given improving single-family trends, easier comps. It sounds like the backlogs in multifamily are still pretty strong. Just if you could walk us through that.

Yes. Adam, this is Rob. So at the midpoint, you’re correct. We’ve got a slight decline. There is one less day to the prior year and, actually, versus first half, you got three less business days. So that’s a big part of the change. And then towards the high end of our guidance, we do show growth for the second half of the year on an average daily sales basis. Like Robert said, if we have reached the trough, we should see that slower growth. But typically, the back half of the year, we do see a seasonal uptick of 5% or so year-over-year. And that’s not baked in right now given the slowdown we saw in the single-family side to start the year. And so that’s the impact you’re going to see in the year-over-year as well. Obviously, if starts to continue to accelerate from where we are today, that will be upside to the guidance we’ve got out there.

Okay. Got it. And then you threw out that 80 basis points benefit to gross margin. Can you walk through exactly what drove that and why it may not continue?

Yes. Like I said, I mean there’s a lot of variables that go into our margins every quarter, right? It can be segment mix, it can be bidding, it can be how available material is to us, labor efficiency. And we do a good job of forecasting that. But like I said, this quarter, we even exceeded our expectations around that, and we’re going to continue to do everything we can to maintain that and to expand on that. But in our guidance, we have not baked in that level.

Okay. So it wasn’t necessarily one specific item, it was just a kind of confluence of factors?

Correct. I mean it’s certainly business performance, right? It wasn’t like a one-time accounting good guy or something like that. It was performance of the business.

Okay guys. Thanks. Best of luck.

Thank you. And our next question comes from the line of Mr. Phil Ng with Jefferies. Please proceed with your question.

Hey guys, congrats on another strong quarter. So Robert, if I heard you correctly, you’re currently anticipating maybe single-family volumes may have troughed in 2Q for your Insulation business. And appreciating your report, volume and mix together, and your volumes were actually up year-over-year in the first half. So should we expect it to be positive in the back half as well? I appreciate you got a little tougher comps there. And then similarly, how should we think about the shape of the year in your distribution business? Is 2Q your trough from a volume standpoint as well?

Yes, good morning Phil. As we consider this, Rob addressed it well. If the positive trends in single-family continue, we expect that to be beneficial in the second half of the year. Based on discussions with builders and our branch operations teams, along with the new specifications we see developing, it's a strong possibility if we reach that low point in Q2. Regarding the distribution side, we anticipate potential growth there as well. It’s important to highlight that our Specialty Distribution performed very well in Q2, and we expect that success to carry into the latter part of the year. We have a positive outlook on the efforts of our field teams and the results they are achieving locally.

Okay. And from a completion cycle standpoint, have you seen things normalize? And would you take start and lag it, call it, 3 to 4 months at this point?

It’s clear that the lag has returned to a more typical level. It may not be completely back to where it was before COVID, but it's improved from months to probably weeks in terms of normalizing. So it's quite close to your question, Phil.

Okay. Super. And then on the commercial and industrial side, Robert, really strong results. You raised your guidance there. Where are you seeing that pickup in activity for this year? And from a bidding activity, any pockets within that commercial and industrial that’s a little stronger? Is it LNG? Is it manufacturing? Any color there? And when we look out to 2024, do you think you could sustain that mid-single-digit growth range in that C&I segment or maybe even accelerate a little bit?

Yes. Let me address two aspects of it. First, regarding the installation side of the business, which is primarily focused on light commercial and the heavy commercial envelope. The team is performing exceptionally well. Our leadership is very motivated and effectively using our tools, like the Lead App, while continuing to make improvements in different regions of the country. We are close to major metropolitan areas related to this business, and they are serving those markets while also expanding from them in the heavy commercial sector. As for distribution, Rob highlighted some strong growth rates. When it comes to specific areas, I would point out data centers on the commercial side. We continue to see much activity in higher education and medical sectors. Moreover, in the mechanical industrial side, liquid natural gas is definitely noteworthy. We're observing exciting projects emerging in Canada, both in maintenance, repair, and operations and new constructions, particularly in the liquid natural gas sector. There is also some significant government work happening in Canada. Furthermore, sectors like food and beverage, alongside large-scale projects such as electric vehicle plants, are contributing to demand and are among the larger projects that we anticipate in terms of execution and bidding.

And then with that outlook on your distribution side, should we expect the growth rate you’re seeing this year accelerate in 2024 or pretty steady?

Yes. I think as we get back to my comment to that would be, Rob may want to add something, but I think if we’re getting back to normalizing distribution volumes, yes, I mean, I think we would expect to see that business continue to grow and outperform which, again, I think they’ve done in the first half here. We look to see momentum in the distribution space for sure.

Yes. And I’d just point out in the second half, the comps on commercial and industrial are a little tougher than the first half. So while we do expect growth, the year-over-year numbers won’t be as strong as we saw in the first half of the year.

Okay, great color guys. Appreciate it.

Thank you. And our next question comes from the line of Mr. Keith Hughes with Truist Securities. Please proceed with your question.

Thank you. We talked a lot about turn and volume and insulation. I just want to switch to distribution. You gave us the breakout in the quarter between industrial, commercial and residential. Do you think that kind of numbers are going to hold for the back half of the year or would you expect either one to accelerate or decelerate?

Yes. I think on the residential side, we’re expecting to see some improvement given what we’ve seen from the starts side of thing on the single-family side. So for sure, we expect to see some improvement there. And then as Robert was just talking about on the commercial and industrial side, a lot of good projects and activity going on there. So we’re expecting to continue kind of that mid-single-digit steady growth in the back half of the year.

Is that growth entirely due to volume, or is there also some price factor included in that mid-single-digit number?

Yes. There’s a small piece of price, but there hasn’t been nearly as much inflation on that side of things as we had on the resi side. And even on the resi side, as you can see in our results, the price number is coming down.

Alright, thank you.

Thank you. And our next question comes from the line of Mr. Noah Merkousko with Stephens. Please proceed with your question.

Good morning and thank you for taking my question. On the installation side, there was very good volume growth during the quarter. You mentioned shifting your focus to more light and heavy commercial projects. Could you clarify whether it is relatively straightforward to reallocate labor and assets between different markets? Additionally, I believe the slowdown in single-family was anticipated by many for quite some time, and I assume other installers will also look to pivot their work accordingly. Do you think you are gaining market share in those segments?

Yes, good morning, Noah, it’s Robert. To start with your question, all of our residential branches are capable of handling light commercial work as they involve very similar products and applications. This means that the labor can easily transition between jobs and locations. However, when it comes to heavy commercial, the labor used for residential-like commercial tasks cannot be shifted over, as it’s specifically tailored for that industry due to its higher technical demands and different applications. That said, our heavy commercial crews are mobile and do travel between cities, making labor transferable within both light and heavy commercial sectors. Regarding the future mix, while you mentioned the single-family segment, our performance indicates that we have surpassed expectations in that area, and we have also gained share in the multifamily sector. This strategy of diversifying our model across various growth avenues—single-family, multifamily, commercial, and industrial—is reflected in our strong results and overall performance.

Got it. That’s helpful. And then for my follow-up, when you acquired Distribution International, you highlighted a pretty strong pipeline of M&A opportunities there. And clearly, you’re executing on that with SPI. So just wanted to get an update there. I mean I know you noted in your prepared remarks, it’s still a very fragmented market. But can you kind of help frame up the opportunity of sizable acquisitions that’s in that space?

Yes. When considering the mechanical insulation market, SPI serves as a notable example. This sector includes mechanical insulation along with commercial insulation, such as metal building insulation, which we've discussed as being extremely fragmented. There are many players of various sizes in this market, all of which contribute to its fragmentation. As Rob and I mentioned earlier, there is an active pipeline of potential deals, and SPI is an excellent company for us to pursue. Additionally, as we noted in our announcement last week, they possess strong M&A capabilities that will enhance TopBuild's existing competencies in this area. This opportunity spans all three segments: residential, commercial, and industrial.

Great, I appreciate all the color. I’ll leave it there.

Thank you. And our next question comes from the line of Mr. Michael Rehaut with JPMorgan. Please proceed with your question.

Thanks, good morning everyone. Thanks for taking my questions. First, I just wanted to kind of circle back to the M&A question just asked. Obviously with SPI there’s still a tremendous amount of opportunity in the mechanical and industrial side and that’s been a big part of your focus and thesis, and it looks like there’s a lot more to come over the next two or three years. How should we think about the residential side though? Obviously, you continue to do various acquisitions there as well. But from a revenue standpoint, they appear a little smaller. Should we expect that kind of trend to continue where perhaps from a revenue standpoint, the bulk of the opportunity is more on the commercial, industrial, mechanical and still some opportunity on the resi side, but more singles versus doubles and home runs on the other parts of the business?

Yes, Mike, this is Robert. I’ll start off. So let’s start on the mechanical side of it. Yes, definitely, plenty of opportunities there, as there’s a lot amount of fragmentation there in that space. And big players, small players, mechanical, metal buildings are really across that space. But we see the same on residential. I just want to point to our performance here. I mean, so this year, two sizable acquisitions, much larger than the average in the space with SRI that we acquired in first quarter, so about a $62 million residential installer there in multiple locations. And then we’re really excited about Best Insulation, which we announced in July, a $100 million company as well. So we like the small ones, we like the medium and the big ones, and you see us delivering at all levels there. So I think on the residential side, you should think about continued opportunity. It is fragmented as well. And just the returns that happen with those acquisitions of all sizes and the execution is excellent for our shareholders. So you’re going to see us active across all of them.

So just before I hit on the second one then, you’re saying that companies like SRI and Best, there’s still a bunch of those types of companies out there and available?

We still see some sizable companies in the space. I’m going to call it, they are I think sizable, higher than the averages, if you will, some of the smaller ones or if you take the average of the ones done across the industry. So there’s still some nice sized targets out there.

The EBIT margin for TruTeam continues to exceed expectations, likely your expectations as well. Even considering that a portion of the gross margin may be a one-time effect concentrated in TruTeam, it still indicates a margin of over 20%. I’m trying to understand what enables this level of sustainability in the margins observed in the first half of 2023. You've mentioned productivity as a factor, and I'm curious if there has been a structural change in the profitability of the segment, possibly linked to better pricing for services in the current resource-constrained environment. I want to understand how much of this improvement can be considered structural as we look ahead to the next couple of years.

Mike, it's Robert. Let me start by emphasizing the importance of execution in the field, supported by our excellent support functions. If you look at the factors contributing to our success, as Rob mentioned, it includes labor productivity and how we optimize our network with our ERP system, which applies to both residential and commercial sectors. Our teams have performed well, particularly in the multifamily area, where teams have improved margins historically discussed. They capitalize on opportunities as they arise and continuously strive for enhancements in our operations, which effectively drives our performance. Our team remains focused, and our field leadership shares that focus. We are consistently working to improve from the bottom quartile, which is ingrained in our culture and pushed by our operations leaders. Hence, I attribute our performance more to our execution rather than any single factor or structural change; we are simply committed to executing our plan.

Yes. And Mike, I’d just add to that, that our guidance implies we expect to continue to expand. I mean that EBITDA margin is great this quarter, right, 23.4% for the install side of the business. But we guide to them being on the higher end of our incremental margin range of 22% to 27%. So the quarter-over-quarter improvement won’t be as great. But if we continue to add at 27%, and a lot of times, as you know, we’re doing much better than 27%, we should be able to continue to expand.

Great. Thanks so much.

Thank you. And our next question comes from the line of Mr. Rafe Jadrosich with Bank of America. Please proceed with your question.

Hi, good morning thanks for taking my questions. Robert, I just wanted to sort of clarify a comment that you made earlier. I think you said that you would expect residential to trough in the second quarter. Is that for the industry in terms of starts? Or is that your own business? And then if it’s for the industry, when would you expect resi to trough within the installation and distribution business?

Yes. This is Robert. So I’ll start with a couple of comments there. So one, we said it could have troughed in the second quarter. Obviously, others have been making comments as to their view on that. I think it’s hard to ignore the starts and the momentum in the starts looking at May and June. So if that momentum keeps going in that direction, you’d say the industry is probably solid. So all that, it really depends on that trajectory of the starts. But definitely given recent trends, recent commentary from builders, specs that we see coming out of the ground, we’d say that’s a good possibility that we and the industry is solid in the second quarter. But we’ll see what happens here coming up in the next couple of months.

Rafe, I was just going to add to that. I mean from a starts perspective, obviously, we saw that. It looks like starts troughed around April, right, and now have come back May, June, and we hope continue that pace. And then we’re obviously lagged from that 3, 4 months. So whether that trough exactly hits us in Q2 or Q3, that’s the question at this point. But it definitely looks like we’re going to be coming out of that here in the second half of the year if this trend on starts continues.

Great. That’s very helpful. And then just the increase of the outlook on the commercial and industrial side for the year, you took that up slightly. Can you talk about like, is there any end market that’s driving that improved outlook specifically? Like what are you seeing by end market? I guess, mostly on the distribution side that’s driving the commercial higher? And then have you seen any improvement in the bidding activity as you look into next year as well?

Yes, Rafe, I’ll start off, this is Rob, and Robert will add on. I mean I think the increase really is driven by our outperformance here in the first half, right, which was really driven on the install side of the business where we saw revenue up in the 23% range year-over-year. I mean we are seeing a nice steady growth on the distribution side, but it’s in about the range that we guided to for the year. But the outperformance has been on the install side. A variety of big projects. Robert can probably add some color there as well. But it’s been across both light and heavy commercial. We’ve seen both sides grow in that 20%-plus type range here in the quarter.

Great. That’s very helpful.

Thank you. And our next question comes from the line of Mr. Reuben Garner with Benchmark Company. Please proceed with your question.

Thank you, good morning everyone. I joined a bit late, so I apologize if this is a repeat question, but I was curious if you are noticing any clear signs that the Inflation Reduction Act is encouraging some of your homebuilder customers to upgrade their insulation, whether that means switching from fiberglass to spray foam or from cellulose to fiberglass or any other upgrades that are taking advantage of the credit?

Reuben, it’s Robert. That’s a good and interesting question. If we look at some of the custom homebuilders, we’re noticing that they are leaning towards better or best installation packages. Part of this shift may be influenced by the factors you mentioned. Many custom builders are aiming to set themselves apart. Additionally, the tax credit from the Inflation Reduction Act has been made slightly more stringent than before, but some credits have increased. This change is certainly catching the attention of various builders, both production and custom. Custom builders may see this as a chance to differentiate the packages they offer. Overall, we believe this is a positive trend for the industry, and there might be early indicators of it happening.

Great. Thanks, congrats on the results.

Thank you.

Thank you. There are no further questions at this time. I would like to turn the floor back over to Mr. Robert Buck, President and CEO, for closing comments.

Thank you for joining us today. We look forward to talking with you in October or early November in our Q3 results. Thank you.

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.