TopBuild Corp - Annual Report: 2018 (Form 10-K)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-K

 

For the fiscal year ended December 31, 2018

 

For the transition period from                to               

 

Commission file number: 1-36870

 

TopBuild Corp.

(Exact Name of Registrant as Specified in its Charter)

 

(386) 304-2200

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

☒ Yes            ☐ No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. 

☐ Yes            ☒ No

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form
10-K.☒

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or 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   ☐      Smaller reporting company   ☐      Non-accelerated filer ☐      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 aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant based on the closing price of $78.34 per share as reported on the New York Stock Exchange on June 29, 2018, was approximately $2.8 billion.

 

Number of shares of common stock outstanding as of February 14, 2019: 34,554,031

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s Proxy Statement for its 2019 Annual Meeting of Shareholders, to be filed with the Securities and Exchange Commission no later than 120 days after December 31, 2018, are incorporated by reference into Part III of this Form 10-K.

 

 

 

TOPBUILD CORP.

TABLE OF CONTENTS

 

 

GLOSSARY

 

We use acronyms, abbreviations, and other defined terms throughout this annual report on Form 10-K, as defined in the glossary below:

 

 

 

 

PART I

 

Item 1.  BUSINESS

 

Overview

 

TopBuild Corp., headquartered in Daytona Beach, Florida, is a leading installer and distributor of insulation and other building products to the United States construction industry.  Prior to June 30, 2015, we operated as a subsidiary of Masco, which trades on the NYSE under the symbol “MAS.”  We were incorporated in Delaware in February 2015 as Masco SpinCo Corp. and we changed our name to TopBuild Corp. on March 20, 2015.  On June 30, 2015, the Separation was completed and on July 1, 2015, we began trading on the NYSE under the symbol “BLD.”

 

Segment Overview

 

We operate in two segments: our Installation segment, TruTeam, which accounts for 67% of our sales, and our Distribution segment, Service Partners, which accounts for 33% of our sales. 

 

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

 

Installation (TruTeam)

 

We provide insulation installation services nationwide through our TruTeam contractor services business which has over 200 installation branches located in 40 states.

 

Various insulation applications we install include:

 

 

In addition to insulation products, which represented 72% of our Installation segment’s sales during the year ended December 31, 2018, we also install other building products including rain gutters, glass and windows,  fireproofing, garage doors, 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.  The amount of insulation installed in a new home is regulated by various building and energy codes. 

 

Our TruTeam customer base includes the largest single-family homebuilders in the U.S. as well as local/single-family custom builders, multi-family builders, commercial general contractors, remodelers, and individual homeowners. 

 

Through our Home Services subsidiary and our Environments for Living® program, we offer a number of services and tools designed to assist builders with applying the principles of building science to new home construction.  We offer pre-construction plan reviews using industry-standard home-energy analysis software, various inspection services, and diagnostic testing.  We believe our Home Services subsidiary is one of the largest Home Energy Rating System Index (HERS) raters in the U.S. 

Distribution (Service Partners)

 

We distribute insulation and other building products including rain gutters, fireplaces, closet shelving, and roofing materials through our Service Partners business, which has over 75 distribution centers located in 32  states.

 

Our Service Partners customer base consists of thousands of insulation contractors of all sizes, gutter contractors, weatherization contractors, other contractors, dealers, metal building erectors, and modular home builders. 

 

For further information on our segments, see Item 8. Financial Statements and Supplementary Data – Note 7. Segment Information.

 

Demand for Our Products and Services

 

Demand for our insulation products and services is driven by new single-family residential and multi-family home construction, commercial construction, remodeling and repair activity, revised building codes that require additional insulation, and the growing need for energy efficiency.  Being a leader in both installation and distribution allows us to reach a broader set of customers more effectively, regardless of their size or geographic location within the U.S.    We recognize that competition for the installation and sale of insulation and other building products occurs in localized geographic markets throughout the country, and, as such, our operating model is based on our geographically diverse branches building and maintaining local customer relationships.  At the same time, our local operations benefit from centralized functions such as purchasing, information technology, sales support, and credit and collections. 

 

Competitive Advantages

 

The market for the distribution and installation of building products is highly fragmented and competitive.  Barriers to entry for local competitors are relatively low, increasing the risk that additional competitors will emerge.  Our ability to maintain our competitive position in our industry depends on a number of factors including our national scale, sales channels, diversified product lines, strong local presence, reduced exposure to residential housing cyclicality and strong cash flows.

 

National scale.  With our national footprint, we provide products and services to each major construction line of business in the U.S.  Our national scale, together with our centralized TopBuild executive management team, allow us to compete locally by:

 

•Providing national and regional builders with broad geographic reach, while maintaining consistent policies and practices that enable reliable, high‑quality products and services across many geographies and building sites

 

•Establishing strong ties to major manufacturers of insulation and other building products that help ensure we are buying competitively, have availability of supply to our local branches and distribution centers, and are driving efficiencies throughout our supply chain

 

•Providing consistent, customized support and geographic coverage to our customers

 

•Maintaining an operating capacity that allows us to ramp‑up rapidly, without major incremental investment, to target forecasted growth in housing starts and construction activity in each of our lines of business anywhere in the U.S.

 

•Leveraging investments in systems and processes and sharing best practices across both our installation and distribution businesses

 

Two avenues to reach the builder.  We believe that having both installation and distribution businesses provides a number of advantages to reaching our customers and driving share gains.  Our installation business customer base includes builders of all sizes.  Our branches go to market with the local brands that small builders recognize and value, and our national footprint is appealing to large builders who value consistency across a broad geography.  Our distribution business focuses on selling to small contractors who are particularly adept at cultivating local relationships with small custom builders.  Being a leader in both installation and distribution allows us to more effectively reach a broader set of builder customers, regardless of their size or geographic location within the U.S., and leverage new construction housing growth wherever it occurs.

Diversified lines of business.    In response to the housing downturn in prior years and to mitigate the cyclicality of residential new home construction, we expanded and enhanced our ability to serve the commercial construction line of business.  This included expanding our commercial operations and sales capacity, adding commercial product offerings, developing relationships with commercial general contractors and building our expertise and reputation for quality service for both light and heavy commercial construction projects. Although the commercial construction is affected by many of the same macroeconomic and local economic factors that drive residential new construction, commercial construction has historically followed different cycles than residential new construction. 

 

Strong local presence.  Competition for the installation and sale of insulation and other building products to builders occurs in localized geographic markets throughout the country.  Builders and contractors in each local market have different options in terms of choosing among insulation installers and distributors for their projects, and value local relationships, quality, and timeliness.  Our installation branches are locally branded businesses that are recognized within the communities in which they operate.  Our distribution centers service primarily local contractors, lumberyards, retail stores and others who, in turn, service local homebuilders and other customers.  Our operating model, in which individual branches and distribution centers maintain local customer relationships, enables us to develop local, long‑tenured relationships with these customers, build local reputations for quality, service and timeliness, and provide specialized products and personalized services tailored to a geographic region.  At the same time, our local operations benefit from centralized functions, such as purchasing, information technology, sales support, and credit and collections, and the resources and scale efficiencies of an installation and distribution business that has a presence across the U.S.

Reduced exposure to residential housing cyclicality.  During industry downturns many insulation contractors, who buy directly from manufacturers during industry peaks, return to purchasing through distributors for small, “Less Than Full Truckload” shipments, reduced warehousing needs, and access to purchases on credit.  This drives incremental customers to Service Partners during these points in the business cycle, offsetting decreases in demand for installation services at TruTeam as a result of a downturn.  We believe that our leadership position in both installation and distribution helps to reduce exposure to cyclical swings in our lines of business.

Strong cash flow, low capital investment, and favorable working capital fund organic growth.  Over the last several years, we have reduced fixed costs and improved our labor utilization.  As a result, we can achieve profitability at lower levels of demand as compared to historical periods.  For further discussion on our cash flows and liquidity, see Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.

 

Major Customers

 

We have a diversified portfolio of customers and no single customer accounted for three percent or more of our total revenues for the year ended December 31, 2018.  Our top ten customers accounted for approximately 10 percent of our total sales in 2018.    

 

Backlog

 

Due to our customers’ need for timely installation of our products, our installation jobs are scheduled and completed within a short timeframe.  We do not consider backlog material to our business.

 

Suppliers

 

Our businesses depend on our ability to obtain an adequate supply of high quality products and components from manufacturers and other suppliers.  We rely heavily on third party suppliers for our products and key components.  We source the majority of our fiberglass building products from four primary U.S.-based residential fiberglass insulation manufacturers: Knauf, CertainTeed, Johns Manville, and Owens Corning.  Failure by our suppliers to provide us with an adequate supply of high quality products on commercially reasonable terms, or to comply with applicable legal requirements, could have a material, adverse effect on our financial condition or operating results.  We believe we generally have positive relationships with our suppliers.

 

Employees

 

As of December 31, 2018, we had approximately 10,300 employees.  Approximately 830 of our employees are currently covered by collective bargaining or other similar labor agreements.

 

Executive Management

 

See Item 10. Directors, Executive Officers, and Corporate Governance. 

 

Legislation and Regulation

 

We are subject to U.S. federal, state, and local regulations, particularly those pertaining to health and safety (including protection of employees and consumers), labor standards/regulations, contractor licensing, and environmental issues.  In addition to complying with current effective requirements and requirements that will become effective at a future date, even more stringent requirements could eventually be imposed on our industries.  Additionally, some of our products and services may require certification by industry or other organizations.  Compliance with these regulations and industry standards may require us to alter our distribution and installation processes and our sourcing, which could adversely impact our competitive position.  Further, if we do not effectively and timely comply with such regulations and industry standards, our operating results could be negatively affected.

 

Additional Information

 

We make available free of charge on our website, www.topbuild.com, our Annual Reports, Quarterly Reports, and Current Reports as soon as reasonably practicable after these reports are filed with or furnished to the SEC. 

 

Use of our Website to Distribute Material Company Information

 

We use our website as a channel of distribution for important Company information. We routinely post on our website important information, including press releases, investor presentations and financial information, which may be accessed by clicking on the Investors section of www.topbuild.com. We may also use our website to expedite public access to time-critical information regarding our Company in advance of or in lieu of distributing a press release or a filing with the SEC disclosing the same information. Therefore, investors should look to the Investors subpage of our website for important and time-critical information.  Visitors to our website can also register to receive automatic e-mail and other notifications alerting them when new information is made available on the Investor Resources subpage of our website. 

Item 1A.  RISK FACTORS

 

There are a number of risks and uncertainties that could affect our business and cause our actual results to differ from past performance or expected results.  We consider the following risks and uncertainties to be those material to our business.  If any of these risks actually occur, our business, financial condition and results of operations could suffer, and the trading price of our common stock could decline.  We urge investors to consider carefully the risk factors described below in evaluating the information contained in this Annual Report. 

 

Our business relies on residential new construction activity, and to a lesser extent on residential repair/remodel and commercial construction activity, all of which are cyclical.

 

Demand for our services is cyclical and highly sensitive to general macroeconomic and local economic conditions over which we have no control.  Macroeconomic and local economic conditions, including consumer confidence levels, fluctuations in home prices, unemployment and underemployment levels, student loan debt, household formation rates, mortgage tax deduction limits, the age and volume of the housing stock, the availability of home equity loans and mortgages and the interest rates for such loans, and other factors, affect consumers’ discretionary spending on both residential new construction projects and residential repair/remodel activity.  The commercial construction market is affected by macroeconomic and local economic factors such as interest rates, credit availability for commercial construction projects, material costs, employment rates, office vacancy rates, and office absorption rates.  Changes or uncertainty regarding these and other factors could adversely affect our results of operations and our financial position. 

 

We may not be successful in identifying and making acquisitions. In addition,  acquisition integrations, such as USI, involve risks that could negatively affect our operating results, cash flows, and liquidity.

 

We have made, and in the future may continue to make, strategic acquisitions as part of our growth strategy.  We may be unable to make accretive acquisitions or realize expected benefits of any acquisitions for any of the following reasons:

 

 

 

 

 

 

Our ability to successfully implement our business plan and achieve targeted financial results is dependent on our ability to successfully integrate acquired businesses.  The process of integrating acquired businesses, may expose us to operational challenges and risks, including, but not limited to:

 

 

 

 

 

 

 

 

 

 

 

 

 

Failure to successfully integrate USI, and any other acquired businesses, may result in reduced levels of revenue, earnings, or operating efficiency than might have been achieved if we had not acquired such businesses.  In addition, our acquisition of USI resulted, and any future acquisitions could result, in the incurrence of additional debt and related interest expense, contingent liabilities, and amortization expenses related to intangible assets, which could have a material adverse effect on our financial condition, operating results, and cash flow. 

 

We may not be able to achieve the benefits that we expect to realize as a result of the acquisition of USI or any future acquisitions.  Failure to achieve such benefits could have an adverse effect on our financial condition and results of operations.

 

We may not be able to realize anticipated cost savings, revenue enhancements, or other synergies from the USI acquisition or any future acquisitions, either in the amount or within the time frame that we expect.  In addition, the costs of achieving these benefits may be higher than, and the timing may differ from, what we expect.  Our ability to realize anticipated cost savings, synergies, and revenue enhancements may be affected by a number of factors, including, but not limited to, the following:

 

 

 

 

 

Specifically, while we expect the USI acquisition or any future acquisition to create opportunities to reduce our combined operating costs, these cost savings reflect estimates and assumptions made by our management, and it is possible that our actual results will not reflect these estimates and assumptions within our anticipated timeframe or at all. 

 

If we fail to realize anticipated cost savings, synergies, or revenue enhancements, our financial results may be adversely affected, and we may not generate the cash flow from operations that we anticipate. 

 

We are dependent on third‑party suppliers and manufacturers to provide us with an adequate supply of quality products, and the loss of a large supplier or manufacturer could negatively affect our operating results.

 

Failure by our suppliers to provide us with an adequate supply of quality products on commercially reasonable terms, or to comply with applicable legal requirements, could have a material adverse effect on our financial condition or operating results.  While we believe that we have generally positive relationships with our suppliers, the fiberglass insulation industry has encountered both shortages and periods of significant oversupply during past housing market cycles, leading to volatility in prices and allocations of supply, affecting our results.  While we do not believe we depend on any sole or limited source of supply, we do source the majority of our building products, primarily insulation, from a limited number of large suppliers.  The loss of a large supplier, or a substantial decrease in the availability of products or components from our suppliers, could disrupt our business and adversely affect our operating results.

 

The long‑term performance of our businesses relies on our ability to attract, develop, and retain talented personnel, including sales representatives, branch managers, installers, and truck drivers, while controlling our labor costs.

 

We are highly dependent on the skills and experience of our senior management team and other skilled and experienced personnel.  The failure to attract and retain key employees could negatively affect our competitive position and operating results. 

 

Our business results also depend upon our branch managers and sales personnel, including those of businesses acquired.  Our ability to control labor costs and attract qualified labor is subject to numerous external factors including prevailing wage rates, labor shortages, the impact of legislation or regulations governing wages and hours, labor relations, immigration, healthcare benefits, and other insurance costs.  In addition, we compete with other companies to recruit and retain qualified installers and truck drivers in a tight labor market, and we invest significant resources in training and motivating them to maintain a high level of job satisfaction.  These positions generally have high turnover rates, which can lead to increased training and retention costs.

 

Because we operate our business through highly dispersed locations across the U.S., our operations may be materially adversely affected by inconsistent local practices and the operating results of individual branches and distribution centers may vary.

 

We operate our business through a network of highly dispersed locations throughout the United States, supported by executives and services at our Branch Support Center in Daytona Beach, Florida, with local branch management retaining responsibility for day-to-day operations and adherence to applicable local laws.  Our operating structure can make it difficult for us to coordinate procedures across our operations.  In addition, our branches and distribution facilities may require significant oversight and coordination from headquarters to support their growth.  Inconsistent implementation of corporate strategy and policies at the local or regional level could materially and adversely affect our business, financial condition, results of operations, and cash flows. 

 

Our profit margins could decrease due to changes in the costs of the products we install and/or distribute.

 

The principal building products that we install and distribute have been subject to price changes in the past, some of which have been significant.  Our results of operations for individual quarters can be, and have been, hurt by a delay between the time building product cost increases are implemented and the time we are able to increase prices for our installation or distribution services, if at all.  Our supplier purchase prices may depend on our purchasing volume or other arrangements with any given supplier.  While we have been able to achieve cost savings through volume purchasing or other arrangements with suppliers in the past, we may not be able to consistently continue to receive advantageous pricing for the products we distribute and install.  If we are unable to maintain pricing consistent with prior periods, our costs could increase and our margins may be adversely affected. 

 

We face significant competition, and increased competitive pressure may adversely affect our business, financial condition, results of operations and cash flows.

 

The market for the distribution and installation of building products is highly fragmented and competitive, and barriers to entry are relatively low.  Our installation competitors include national contractors, regional contractors, and local contractors, and we face many or all of these competitors for each project on which we bid.  Our insulation distribution competitors include specialty insulation distributors (one multi‑regional, several regional, and numerous local).  In some instances, our insulation distribution business sells products to companies that may compete directly with our installation service business.  We also compete with broad line building products distributors, big box retailers, and insulation manufacturers.  In addition to price, we believe that competition in our industry is based largely on customer service and the quality and timeliness of installation services and distribution product deliveries in each local market.

 

In the event that increased demand leads to higher prices for the products we sell and install, we may have limited ability to pass on price increases in a timely manner or at all due to the fragmented and competitive nature of our industry. 

 

Our business is seasonal and is susceptible to adverse weather conditions and natural disasters.  We also may be adversely affected by any natural or man-made disruptions to our facilities.

 

We normally experience stronger sales during the third and fourth calendar quarters, corresponding with the peak season for residential new construction and residential repair/remodel activity.  Sales during the winter weather months are seasonally slower due to the lower construction activity.  Historically, the installation of insulation lags housing starts by several months. 

 

In addition, to the extent that hurricanes, severe storms, earthquakes, droughts, floods, fires, other natural disasters, or similar events occur in the geographic areas in which we operate, our business may be adversely affected. 

 

Any widespread disruption to our facilities resulting from a natural disaster, an act of terrorism, or any other cause could damage a significant portion of our inventory, and could materially impair our ability to provide installation and/or distribution services for our customers. 

 

Claims and litigation could be costly.

 

We are, from time to time, involved in various claims, litigation matters, and regulatory proceedings that arise in the ordinary course of our business and which could have a material adverse effect on us.  These matters may include contract disputes, automobile liability and other personal injury claims, warranty disputes, environmental claims or proceedings, other tort claims, employment and tax matters, the quality of products sourced from our suppliers, and other proceedings and litigation, including class actions.  In addition, we are exposed to potential claims by our employees or others based on job related hazards. 

 

Our builder and contractor customers are subject to product liability, casualty, negligence, construction defect, breach of contract, warranty and other claims in the ordinary course of their business.  We rely on manufacturers and other suppliers to provide us with most of the products we install.  Because we do not have direct control over the quality of such products manufactured or supplied by such third-party suppliers, we are exposed to risks relating to the quality of such products.  In addition, we are exposed to potential claims arising from the conduct of our employees, homebuilders and other subcontractors, for which we may be liable contractually or otherwise.  Our contractual arrangements with our builder and contractor customers may include our agreement to defend and indemnify them against various liabilities. 

 

Product liability, workmanship warranty, casualty, negligence, construction defect, breach of contract and other claims and legal proceedings can be expensive to defend and can divert the attention of management and other personnel for significant periods of time, regardless of fault or the ultimate outcome.  In addition, lawsuits relating to construction defects typically have statutes of limitations that can run as long as ten years.  Claims of this nature could also have a negative impact on customer confidence in us and our services. 

 

Although we intend to defend all claims and litigation matters vigorously, given the inherently unpredictable nature of claims and litigation, we cannot predict with certainty the outcome or effect of any claim or litigation matter.

 

We expect to maintain insurance against some, but not all, of these risks of loss resulting from claims and litigation.  We may elect not to obtain insurance if we believe the cost of available insurance is excessive relative to the risks presented.  The levels of insurance we maintain may not be adequate to fully cover any and all losses or liabilities.  If any significant accident, judgment, claim, or other event is not fully insured or indemnified against, it could have a material adverse impact on our business, financial condition, and results of operations.

 

We may not be able to identify new products or new product lines and integrate them into our distribution network, which may impact our ability to compete.  Our expansion into new markets may present competitive, distribution, and regulatory challenges that differ from current ones.

 

Our business depends in part on our ability to identify future products and product lines that complement existing products and product lines and that respond to our customers’ needs.

 

We may not be able to compete effectively unless our product selection keeps up with trends in the markets in which we compete or trends in new products, which could cause us to lose market share.  In addition, our ability to integrate new products and product lines into our distribution network could affect our ability to compete.

 

We are subject to competitive pricing pressure from our customers.

 

Residential homebuilders historically have exerted significant pressure on their outside suppliers to keep prices low in the highly fragmented building products supply and services industry.  In addition, consolidation among homebuilders, and changes in homebuilders’ purchasing policies or payment practices could result in additional pricing pressure.

 

The development of alternatives to distributors in the supply chain could cause a decrease in our sales and operating results and limit our ability to grow our business.

 

Our distribution customers could begin purchasing more of their products directly from manufacturers, which would result in decreases in our net sales and earnings.  Our suppliers could invest in infrastructure to expand their own local sales force and sell more products directly to our distribution customers, which also would negatively impact our business. 

 

If we are required to take significant non‑cash charges, our financial resources could be reduced and our financial flexibility may be negatively affected.

 

We have significant goodwill and other intangible assets related to business combinations on our balance sheet.  The valuation of these assets is largely dependent upon the expectations for future performance of our businesses.  Expectations about the growth of residential new construction, commercial construction, and residential repair/remodel activity may impact whether we are required to recognize non‑cash, pre‑tax impairment charges for goodwill and other indefinite‑lived intangible assets or other long‑lived assets.  If the value of our goodwill, other intangible assets, or long‑lived assets is further impaired, our earnings and stockholders’ equity would be adversely affected and may impact our ability to raise capital in the future.

 

Compliance with government regulation and industry standards could impact our operating results.

 

We are subject to federal, state, and local government regulations, particularly those pertaining to health and safety, including protection of employees and consumers; employment laws, including immigration and wage and hour regulations; contractor licensing; and environmental issues.  In addition to complying with current requirements, even more stringent requirements could be imposed in the future.  Compliance with these regulations and industry standards is costly and may require us to alter our installation and distribution processes, product sourcing, or business practices, and makes recruiting and retaining labor in a tight labor market more challenging.  Compliance with these regulations and industry standards could also divert our attention and resources to compliance activities, and could cause us to incur higher costs.  Further, if we do not effectively and timely comply with such regulations and industry standards, our results of operations could be negatively affected and we could become subject to substantial penalties or other legal liability.

 

Changes in employment laws may adversely affect our business.

 

Various federal and state labor laws govern the relationship with our employees and impact operating costs.  These laws include:

 

 

 

 

 

 

 

We have a significant exposure to changes in laws governing our relationships with our employees, including wage and hour laws and regulations, fair labor standards, minimum wage requirements, overtime pay, unemployment tax rates, workers’ compensation rates, citizenship requirements and payroll taxes, which changes would have a direct impact on our operating costs.  Significant additional government-imposed increases in the preceding areas could have a material adverse effect on our business, financial condition and results of operations.

 

In addition, various states in which we operate are considering or have already adopted new immigration laws or enforcement programs, and the U.S. Congress and Department of Homeland Security from time to time consider and implement changes to federal immigration laws, regulations or enforcement programs.  These changes may increase our compliance and oversight obligations, which could subject us to additional costs and make our hiring process more cumbersome, or reduce the availability of potential employees. Although we verify the employment eligibility status of all our employees, including through participation in the “E-Verify” program where required, some of our employees may, without our knowledge, be unauthorized workers.  Use of the “E-Verify” program does not guarantee that we will properly identify all applicants who are ineligible for employment.  Unauthorized workers are subject to deportation and may subject us to fines or penalties and, if any of our workers are found to be unauthorized, we could experience adverse publicity that negatively impacts our brand and may make it more difficult to hire and retain qualified employees, which could disrupt our operations.  We could also become subject to fines, penalties and other costs related to claims that we did not fully comply with all recordkeeping obligations of federal and state immigration laws. These factors could have a material adverse effect on our business, financial condition and results of operations.

 

Union organizing activity and work stoppages could delay or reduce availability of products that we install and increase our costs.

 

Approximately 830 of our employees are currently covered by collective bargaining or other similar labor agreements that expire on various dates from 2019 through 2027.  Any inability by us to negotiate collective bargaining arrangements could cause strikes or other work stoppages, and new contracts could result in increased operating costs.  If any such strikes or other work stoppages occur, or if other employees become represented by a union, we could experience a disruption of our operations and higher labor costs.  Further, if a significant number of additional employees were to unionize, including in the wake of any future legislation that makes it easier for employees to unionize, these risks would increase.  In addition, certain of our suppliers have unionized work forces, and certain of the products we install and/or distribute are transported by unionized truckers.  Strikes, work stoppages, or slowdowns could result in slowdowns or closures of facilities where the products that we install and/or distribute are manufactured, or could affect the ability of our suppliers to deliver such products to us.  Any interruption in the production or delivery of these products could delay or reduce availability of these products and increase our costs.

 

If we encounter difficulties with our information technology systems, we could experience problems with customer service, inventory, collections, and cost control.

 

Our operations are dependent upon our information technology systems to manage customer orders on a timely basis, to coordinate our installation and distribution activities across locations, and to manage invoicing.  If we experience problems with our information technology systems, we could experience, among other things, delays in receiving customer orders, placing orders with suppliers, and scheduling production, installation services, or shipments.

 

A substantial disruption in our information technology systems could have an adverse impact on revenue, harm our reputation, and cause us to incur legal liability and costs, which could be significant, to address and remediate such events and related security concerns.

 

In addition, we could be adversely affected if any of our significant customers or suppliers experienced any similar events that disrupted their respective business operations or damaged their reputations.

 

In the event of a cybersecurity incident, we could experience operational interruptions, incur substantial additional costs, become subject to legal or regulatory proceedings or suffer damage to our reputation.

 

In addition to the disruptions that may occur from interruptions in our information technology systems, cybersecurity threats and sophisticated and targeted cyberattacks pose a risk to our information technology systems.  We have established security policies, processes and defenses designed to help identify and protect against intentional and unintentional misappropriation or corruption of our information technology systems and disruption of our operations.  Despite these efforts, our information technology systems may be damaged, disrupted or shut down due to attacks by unauthorized access, malicious software, computer viruses, undetected intrusion, hardware failures or other events, and in these circumstances our disaster recovery plans may be ineffective or inadequate.  These breaches or intrusions could lead to business interruption, exposure of proprietary or confidential information, data corruption, damage to our reputation, exposure to legal and regulatory proceedings and other costs.  Such events could have a material adverse impact on our financial condition, results of operations and cash flows.  In addition, we could be adversely affected if any of our significant customers or suppliers experiences any similar events that disrupt their business operations or damage their reputation.

 

We maintain monitoring practices and protections of our information technology to reduce these risks and test our systems on an ongoing basis for potential threats.  We carry cybersecurity insurance to help mitigate the financial exposure and related notification procedures in the event of intentional intrusion.  There can be no assurance, however, that our efforts will prevent the risk of a security breach of our databases or systems that could adversely affect our business.

 

Our business relies significantly on the expertise of our employees, and we generally do not have intellectual property that is protected by patents.

 

Our business is significantly dependent upon our expertise in installation and distribution logistics, including significant expertise in the application of building science through our Environments for Living® program.  We rely on a combination of trade secrets and contractual confidentiality provisions and, to a much lesser extent, copyrights and trademarks, to protect our proprietary rights.  Accordingly, our intellectual property is more vulnerable than it would be if it were protected primarily by patents.  We may be required to spend significant resources to monitor and protect our proprietary rights, and in the event a misappropriation or breach of our proprietary rights occurs, our competitive position in the market may be harmed.  In addition, competitors may develop competing technologies and expertise that renders our expertise obsolete or less valuable.

 

Changes in building codes and consumer preferences could affect our ability to market our service offerings and our profitability.  Moreover, if we do not respond to evolving customer preferences or changes in building standards, or if we do not maintain or expand our leadership in building science, our business, results of operation, financial condition, and cash flow would be adversely affected.

 

Each of our lines of business is impacted by local and state building codes and consumer preferences, including a growing focus on energy efficiency.  Our competitive advantage is due, in part, to our ability to respond to changes in consumer preferences and building codes.  However, if our installation and distribution services do not adequately or quickly adapt to changing preferences and building standards, we may lose market share to competitors, which would adversely affect our business, results of operation, financial condition, and cash flows.  Further, our growth prospects could be harmed if consumer preferences and building standards evolve more slowly than we anticipate towards energy‑efficient service offerings, which are more profitable than minimum code service offerings. 

 

We may have future capital needs and may not be able to obtain additional financing on acceptable terms.

 

Our future capital requirements will depend on many factors, including industry and market conditions, our ability to successfully complete future business combinations and the expansion of our existing operations.  We anticipate that we may need to raise additional funds in order to grow our business and implement our business strategy.  Economic and credit market conditions, the performance of the construction industry, and our financial performance, as well as other factors may constrain our financing abilities.  Our ability to secure additional financing and to satisfy our financial obligations will depend upon our future operating performance; the availability of credit; economic conditions; and financial, business, and other factors, many of which are beyond our control.  Any financing, if available, may be on terms that are not favorable to us and will be subject to changes in interest rates and the capital markets environment.  If we cannot obtain adequate capital, we may not be able to fully implement our business strategy and our business, results of operations and financial condition could be adversely affected.

 

Our indebtedness and restrictions in our existing credit facility, Senior Notes or any other indebtedness we may incur in the future, could adversely affect our business, financial condition, results of operations, ability to make distributions to shareholders, and the value of our common stock.

 

Our indebtedness could have significant consequences on our future operations, including:

 

 

 

    

   

 

Any of the above-listed factors could have an adverse effect on our business, financial condition and results of operations and our ability to meet our payment obligations.  We cannot assure you that our business will generate cash flow from operations, or that future borrowings will be available to us under our credit facility in an amount sufficient to enable us to meet our payment obligations and to fund other liquidity needs.  If we are not able to generate sufficient cash flow to service our debt obligations, we may need to refinance or restructure our debt, sell assets, reduce or delay capital investments, or seek to raise additional capital, and some of these activities may be on terms that are unfavorable or highly dilutive.  Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time.  If we are unable to implement one or more of these alternatives, we may not be able to meet our payment obligations.

 

Certain of our variable rate indebtedness uses LIBOR as a benchmark for establishing the rate of interest. LIBOR is the subject of recent national, international and other regulatory guidance and proposals for reform.  These reforms and other pressures may cause LIBOR to be replaced with a new benchmark or to perform differently than in the past. The consequences of these developments cannot be entirely predicted, but could include an increase in the cost of our variable rate indebtedness.

 

Our existing term loan, revolving credit facility and the indenture governing our Senior Notes limit, and any future credit facility or other indebtedness we enter into may limit, our ability to, among other things:

 

 

 

 

 

 

 

Our revolving credit facility contains, and any future credit facility or other debt instrument we may enter into will also likely contain, covenants requiring us to maintain certain financial ratios and meet certain tests, such as a fixed charge coverage ratio, a leverage ratio, and a minimum test.  Our ability to comply with those financial ratios and tests can be affected by events beyond our control, and we may not be able to comply with those ratios and tests when required to do so under the applicable debt instruments.

 

Adverse credit ratings could increase our costs of borrowing money and limit our access to capital markets and commercial credit.

 

Moody’s Investor Service and Standard & Poor’s routinely evaluate our credit ratings related to our Senior Notes.  If these rating agencies downgrade any of our current credit ratings, our borrowing costs could increase and our access to the capital and commercial credit markets could be adversely affected.

 

In connection with the Separation, Masco indemnified us for certain liabilities and we indemnified Masco for certain liabilities.  If we are required to act under these indemnities to Masco, we may need to divert cash to meet those obligations, which could adversely affect our financial results.  Moreover, the Masco indemnity may not be sufficient to compensate us for the full amount of liabilities for which it may be liable, and Masco may not be able to satisfy its indemnification obligations to us in the future.

 

Indemnities that we may be required to provide Masco are not subject to any cap, may be significant, and could negatively affect our business, particularly indemnities relating to our actions that could affect the tax‑free nature of the Separation.  Third parties could also seek to hold us responsible for any of the liabilities that Masco has agreed to retain, and under certain circumstances, we may be subject to continuing contingent liabilities of Masco following the Separation, such as certain shareholder litigation claims.  Further, Masco may not be able to fully satisfy its indemnification obligations or such indemnity obligations may not be sufficient to cover our liabilities.  Moreover, even if we ultimately succeed in recovering from Masco any amounts for which we are held liable, we may be temporarily required to bear these losses ourselves.  Each of these risks could negatively affect our business, results of operations, liquidity, and financial condition.

 

Compliance with and changes in tax laws could adversely affect our performance.

 

We are subject to extensive tax liabilities imposed by multiple jurisdictions including income taxes; indirect taxes which include excise and duty, sales and use, and gross receipts taxes; payroll taxes; franchise taxes; withholding taxes; and ad valorem taxes.  New tax laws and regulations, and changes in existing tax laws and regulations, are continuously being enacted or proposed which could result in increased expenditures for tax liabilities in the future.  Many of these liabilities are subject to periodic audits by the respective taxing authority.  Subsequent changes to our tax liabilities as a result of these audits may subject us to interest and penalties.

 

Risks Relating to Our Common Stock

 

The price of our common stock may fluctuate substantially, and the value of your investment may decline.

 

The market price of our common stock could fluctuate significantly due to a number of factors, many of which are beyond our control, including:

 

 

 

 

 

 

 

 

 

 

Provisions in our certificate of incorporation and bylaws, and certain provisions of Delaware law, could delay or prevent a change in control.

 

The existence of some provisions of our certificate of incorporation and bylaws and Delaware law could discourage, delay, or prevent a change in control that a stockholder may consider favorable.  These include provisions:

 

 

 

 

In addition, we are subject to Section 203 of the Delaware General Corporation Law, which may have an anti-takeover effect with respect to transactions not approved in advance by our board of directors, including discouraging takeover attempts that could have resulted in a premium over the market price for shares of our common stock.

 

These provisions apply even if a takeover offer is considered beneficial by some stockholders and could delay or prevent an acquisition that our board of directors determines is not in our and our stockholders’ best interests.

 

Our bylaws designate a state or federal court located within the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a preferred judicial forum for disputes with us or our directors, officers, or other employees.

 

Our bylaws provide that, unless we consent in writing to the selection of an alternative forum, the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any director, officer, or other employee to us or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of Delaware General Corporation Law, our certificate of incorporation (including any certificate of designations for any class or series of our preferred stock), or our bylaws, in each case, as amended from time to time, or (iv) any action asserting a claim governed by the internal affairs doctrine, shall be a state or federal court located within the State of Delaware, in all cases subject to the court’s having personal jurisdiction over the indispensable parties named as defendants.  Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock is deemed to have received notice of, and consented to, the foregoing provision.  This forum selection provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable or cost‑effective for disputes with us or our directors, officers, or other employees, which may discourage such lawsuits against us and our directors, officers, and employees.

 

Item 1B.  UNRESOLVED STAFF COMMENTS

 

None.

 

Item 2.  PROPERTIES

 

We operate over 200 installation branch locations and over 75 distribution centers in the United States, most of which are leased.  In January 2017, we moved into our new, 65,700 square foot Branch Support Center located at 475 North Williamson Boulevard in Daytona Beach, FL 32114.  This lease expires in June 2029, assuming no exercise of any options set forth in the lease.  We believe that our facilities have sufficient capacity and are adequate for our installation and distribution requirements.

 

Item 3.  LEGAL PROCEEDINGS

 

None.

 

Item 4.  MINE SAFETY DISCLOSURES

 

Not applicable.

PART II

 

Item 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information and Holders of our Common Stock.  Our common stock is traded on the NYSE under the symbol “BLD”.  As of February 14, 2019, there were approximately 2,838 holders of our issued and outstanding common stock.

 

Dividends.  No dividends were paid during the years ended December 31, 2018 and 2017.  Our Amended Credit Agreement, in certain circumstances, limits the amount of dividends we may distribute.  We do not anticipate declaring cash dividends to holders of our common stock in the foreseeable future.

 

Issuer Purchases of Equity Securities.  The following table provides information regarding the repurchase of our common stock for the three months ended December 31, 2018, in thousands, except share and per share data:

 

 

All repurchases were made using cash resources.  Excluded from this disclosure are shares repurchased to settle statutory employee tax withholdings related to the vesting of stock awards and the exercise of stock options.

 

Performance Graph and Table.  The following graph and table compares the cumulative total return of our common stock from July 1, 2015, the date on which our common stock began trading on the NYSE, through December 31, 2018, with the total cumulative return of the Russel 2000 Index and the Standard & Poor’s 500 Index.  The graph and table assume an initial investment of $100 in our common stock and each of the two indices at the close of business on July 1, 2015, and reinvestment of dividends.

 

 

 

 

 

 

 

Item 6.  SELECTED HISTORICAL FINANCIAL DATA

 

The following table sets forth selected historical financial data that should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited financial statements and notes thereto, included in this Annual Report.  The Consolidated Statements of Operations data for the years ended December 31, 2018,  2017, and 2016, and the Consolidated Balance Sheet data as of December 31, 2018 and 2017, are derived from our audited financial statements included in this Annual Report.  The Consolidated Statements of Operations data for the year ended December 31, 2015 and 2014, and the Consolidated Balance Sheet data as of December 31, 2016, 2015, and 2014, were derived from our audited financial statements not included in this Annual Report.  The selected historical financial data in this section is not intended to replace our historical financial statements and the related notes thereto.  Prior to the Separation, our historical financial results included allocations of general and corporate expense from Masco; therefore, our historical results for periods prior to the Separation are not necessarily comparable to our subsequently reported results.  For more information, see Item 8. Financial Statements and Supplementary Data – Note 1. Summary of Significant Accounting Policies.

 

 

Item 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The financial and business analysis below provides information which we believe is relevant to an assessment and understanding of our financial position, results of operations, and cash flows.  This financial and business analysis should be read in conjunction with the financial statements and related notes.

 

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 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; our ability to maintain our competitive position; and our ability to realize the expected benefits of our acquisitions.  We discuss the material risks we face under the caption entitled “Risk Factors” in Item 1A of this Annual Report.  Our forward-looking statements in this Annual Report speak only as of the date of this Annual Report.  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.

 

Executive Summary

 

We are a leading installer and distributor of insulation and other building products to the U.S. construction industry.  Demand for our products and services is driven primarily by residential new construction, commercial construction, and residential repair/remodel activity throughout the U.S.  A number of local and national factors influence activity in each of our lines of business, including demographic trends, interest rates, employment levels, business investment, supply and demand for housing stock, availability of credit, foreclosure rates, consumer confidence, and general economic conditions. 

 

Activity in the construction industry is seasonal, typically peaking in the summer months.  Because installation of insulation historically lags housing starts by several months, we generally see a corresponding benefit in our operating results during the third and fourth quarters.

 

Competitive Advantages

 

We believe we are well positioned to grow our business both organically and through strategic acquisitions as a result of a number of competitive advantages, including:   

 

National Scale.  Our national scale enables us to drive supply chain efficiencies and provide the tools necessary for our branches and distribution centers to effectively compete locally.  Given the highly fragmented homebuilding industry, our leadership positions in installation, distribution, and building science services allow us to tailor our approach to each local market, which differs in characteristics such as customer mix, competitive activity, building codes, and labor availability.  Moreover, serving multiple lines of business provides additional revenue growth potential with which to leverage our fixed costs, and reduces our exposure to the cyclical swings in residential new construction.  The combined buying power of TruTeam and Service Partners strengthens our ties to the major manufacturers of insulation and other building products.

 

Strong Local Presence.    Competition for the installation and sale of insulation and other building products to builders occurs in localized geographic markets across the country.  Builders in each local market have different options in terms of choosing among insulation installers and distributors for their projects and products and value local relationships, quality, and timeliness.  Our national footprint includes over 200 branches in our Installation segment, which are locally branded businesses that are recognized within the communities in which they operate.  We also have over 75  distribution centers in our Distribution segment, primarily serving local contractors, lumberyards, retails stores, and others who, in turn, service local homebuilders and other customers.  Through both businesses we have developed local, long-tenured relationships with a reputation for quality, service, and timeliness.

 

Two Avenues to Reach the Builder.  Being a leader in both installation and distribution allows us to more effectively reach a broader set of builder customers, regardless of their size or geographic location within the U.S., and leverage housing growth wherever it occurs.

 

Strategy

 

Our long-term strategy is to grow net sales, income, and operating cash flows and remain the leading insulation installer and distributor by revenue.  In order to achieve these goals, we plan to:

 

 

 

 

 

Our operating results depend heavily on residential new construction activity and, to a lesser extent, on commercial construction and residential repair/remodel activity, all of which are cyclical.  We are also dependent on third-party suppliers and manufacturers providing us with an adequate supply of high-quality products. 

 

Material Trends in Our Business

 

We remain cautiously optimistic about the U.S. housing market. The U.S. housing market has grown from approximately 587,000 housing starts in 2010 to approximately 1,256,000 housing starts in 2018 (based on November 2018 seasonally adjusted figure from the U.S. Census Bureau), well below the 50-year historical average of approximately 1.4 million to 1.5 million housing starts per year. While the current headwinds of housing affordability, increasing interest rates, material inflation, credit availability, student debt and labor shortages within the construction industry are moderating the rate of recovery, we believe that they are also extending the recovery cycle. We believe there is pent-up demand for housing and that household formations and the available housing supply point towards continued increasing demand for affordable new home construction. 

 

Seasonality

 

We normally experience stronger sales during the third and fourth calendar quarters, corresponding with the peak season for residential new construction and residential repair/remodel activity.  Sales during the winter weather months are typically slower due to lower construction activity.  Historically, the installation of insulation lags housing starts by several months.

 

 

 

 

Results of Operations

 

We report our financial results in conformity with GAAP. 

 

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

 

 

Comparison of the Years Ended December 31, 2018 and December 31, 2017

 

Sales and Operations

 

Net sales for 2018 increased 25.1 percent, or $478.0 million, to $2.4 billion.  The increase was principally driven by our ten acquisitions completed during 2018 and 2017, primarily our acquisition of USI in May 2018, increased organic sales volume, and increased selling prices.  Our sales benefited primarily from the overall continued improvement in the housing market, as well as our continued focus on organically growing our residential and commercial activity. 

 

Our gross profit margin was 24.2 percent for both 2018 and 2017.  While gross profit margin was under significant pressure in 2018 due to unprecedented material cost increases, we were able to successfully pass these increases through to customers.  The material cost increases in 2018 were primarily due to tighter supply and higher freight costs.

 

Selling, general, and administrative expense, exclusive of the significant legal settlement discussed below, as a percentage of sales was 15.4 percent for both 2018 and 2017.  Higher amortization, acquisition and closure costs related to the USI acquisition were offset by USI acquisition synergies, lower fixed costs as a percentage of sales due to higher sales volume and lower legal expenses.  We paid $30 million during 2017 in final settlement of a breach of contract action in connection with our termination of an insulation supply agreement with Owens Corning.

 

Operating margins were 8.8 percent and 7.2 percent for 2018 and 2017, respectively, inclusive of the Owens Corning legal settlement. The increase in operating margins for 2018 resulted from the $30 million legal settlement with Owens Corning incurred in the prior year, higher selling prices, USI acquisition synergies, lower fixed costs as a percentage of sales due to higher sales volume and lower legal expenses partially offset by higher material costs and higher amortization and acquisition expenses including closure and related costs as described below.

Closure and Related Costs

 

We incurred closure costs of $6.7 million related to the acquisition of USI, including the closing of USI’s St. Paul, Minnesota corporate office and consolidation of certain administrative functions to our Daytona Beach, Florida, Branch Support Center. See Item 8. Financial Statements and Supplementary Data – Note 15. Closure Costs. We incurred expenses of $2.0 million in 2017 related to the consolidation of certain back-office operations to our Daytona Beach, Florida, Branch Support Center.

 

Other Expense, Net

 

Other expense, net, which primarily consists of interest expenses, increased $19.3 million to $28.1 million in 2018 compared with 2017.  The increase is primarily related to the issuance of our $400 million Senior Notes and our borrowing of the $100 million delayed draw term loan to fund our acquisition of USI, as well as the issuance of $26.6 million of equipment notes in 2018.

 

Income Tax (Expense) Benefit

 

Our effective tax rate increased from (23.5) percent in 2017 to 25.5 percent in 2018.  The higher 2018 rate was primarily due to a one-time beneficial adjustment in 2017 of our deferred tax assets and liabilities to reflect the change in the federal statutory rate from 35 percent to 21 percent, enacted in December of 2017 and effective January 1, 2018. The Tax Cuts and Jobs Act also impacted our effective tax rate for 2018, by the elimination of the §199 Domestic Production Activities Deduction and by increased limitations on entertainment expenses and executive compensation. Our effective tax rate for 2018 was also impacted by additional taxes on transaction costs related to the acquisition of USI that were capitalized for tax, offset by a benefit from share-based compensation.

 

Comparison of the Years Ended December 31, 2017 and December 31, 2016

 

Sales and Operations

 

Net sales for 2017 increased 9.4 percent, or $163.4 million, to $1.9 billion.  The increase was principally driven by our seven acquisitions completed during 2017 and 2016, increased organic sales volume, and overall increased selling prices.  Our sales benefited primarily from the overall continued improvement in the housing market, as well as continued focus on organically growing our residential and commercial activity.  

   

Our gross profit margins were 24.2 percent and 23.0 percent for 2017 and 2016, respectively.  Gross profit margin was positively impacted by favorable leverage on overall higher sales volume, increased selling prices, and improved labor utilization, partially offset by higher material cost. 

 

Selling, general, and administrative expense, exclusive of the significant legal settlement discussed below, as a percent of sales was 15.4 percent and 16.0 percent for 2017 and 2016, respectively.  Decreased selling, general, and administrative expense as a percent of sales was a result of lower salaries expense relative to sales, lower health insurance expense, partially offset by higher bonus, share-based compensation, and amortization expenses, as well as closure and related costs noted below.  We incurred a $30 million legal settlement during 2017, related to the settlement of a breach of contract action related to our termination of an insulation supply agreement with Owens Corning. 

  

Operating margins, exclusive of the significant legal settlement discussed above, were 8.8 percent and 7.0 percent for the 2017 and 2016, respectively.  The increase in operating margins was a result of overall increased sales volume, higher selling prices, and lower health insurance costs, partially offset by higher share-based compensation, amortization, and bonus expenses. 

   

Closure and Related Costs

 

We incurred expense of $2.0 million in 2017, related to the consolidation of certain back-office operations to our Daytona Beach, Florida, Branch Support Center.

Other Expense, Net 

   

Other expense, net, increased $3.5 million to $8.8 million in 2017 compared with 2016.  The increase primarily related to the $1.1 million loss on extinguishment of debt as well as higher interest expense due to our higher outstanding long-term debt balance related to our debt refinancing completed on May 5, 2017.   

   

Income Tax Benefit (Expense)

   

Our effective tax rate decreased from 37.6 percent in 2016 to (23.5) percent in 2017.  The lower 2017 rate was primarily due to a beneficial adjustment of our deferred tax assets and liabilities to reflect the change in the federal statutory rate from 35 percent to 21 percent, enacted in December of 2017 and effective January 1, 2018, as well as a benefit from share-based compensation.    

 

2018 and 2017 Business Segment Results

 

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

 

 

2018 and 2017 Business Segment Results Discussion

 

Changes in operating profit margins in the following business segment results discussion exclude general corporate expense, net in 2018 and 2017, as applicable.

 

The construction industry has continued to expand both in residential new home and commercial construction; however, it is subject to inflationary pressures on costs.  While we are seeing the impact of this growth with increases in the cost of building materials, we have been successful to date in achieving price increases, which have more than offset the increased material costs. 

 

Installation

 

Sales

 

Sales increased $399.7 million, or 31.2 percent, in 2018 compared to 2017.  Sales increased 21.2 percent from acquired branches and 4.2 percent due to increased selling prices.  Sales also increased due to increased sales volume related to a higher level of activity in new home construction and an increased sales volume of commercial installation.    

 

Operating Results

 

Operating margins in the Installation segment were 11.7 percent and 8.5 percent for 2018 compared to 2017.  The increase in operating margins is related to the $30 million legal settlement with Owens Corning incurred in the prior year, as well as higher selling prices, USI acquisition synergies, lower legal expenses and lower fixed costs as a percentage of sales due to higher sales volume partially offset by higher material costs, and higher amortization, acquisition and closure costs related to the USI acquisition.    

 

Distribution

 

Sales

 

Sales increased $100.6 million, or 14.0 percent, in 2018 compared to 2017.  Sales increased 7.2 percent due to increased selling prices and 6.7 percent from branches acquired in 2018.

 

Operating Results

 

Operating margins in the Distribution segment were 9.6 percent and 9.5 percent for 2018 and 2017, respectively.  Operating margins were positively impacted by higher selling prices, which were partially offset by increased material costs and higher amortization expense from acquisitions.

2017 and 2016  Business Segment Results

 

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

 

 

2017 and 2016 Business Segment Results Discussion

 

Changes in operating profit margins in the following business segment results discussion exclude general corporate expense, net in 2017 and 2016, as applicable.

   

The construction industry continues to expand both in residential new home and commercial construction, however it is subject to inflationary pressures on costs.  While we are seeing the impact of this growth with increases in the cost of building materials, we have been successful to date in achieving price increases, which more than offset the increased commodity costs. 

   

Installation 

   

Sales 

   

Sales increased $131.1 million, or 11.4 percent, in 2017 compared to 2016.  Sales increased 6.3 percent from acquired branches and 1.5 percent due to increased selling prices.  Sales also increased due to increased sales volume related to a higher level of activity in new home construction and an increased sales volume of commercial installation. 

 

Operating Results

 

Operating margins in the Installation segment were 8.5 percent and 8.4 percent for 2017 compared to 2016.  The increase in operating margins was primarily due to increased sales volume and related absorption of fixed costs, higher selling prices, improved sales productivity, as well as the benefits associated with cost savings initiatives.  The increase was partially offset by the $30 million legal settlement with Owens Corning, as well as higher legal fee expense and higher material cost.  Exclusive of the significant legal settlement, operating margins were 10.9 percent for 2017.

   

Distribution 

   

Sales 

   

Sales increased $43.1 million, or 6.4 percent, in 2017 compared to 2016.  The increase was primarily due to increased sales volume related to a higher level of activity in new home construction.  Sales also benefited from a 0.1 percent increase in selling prices.

   

Operating Results 

   

Operating margins in the Distribution segment were 9.5 percent and 8.8 percent for 2017 compared to 2016.  Operating margins were positively impacted by increased sales volume related to a higher level of activity in new home construction as well as improved labor productivity and higher selling prices.  The increase was partially offset by an increase in material cost.

   

Commitments and Contingencies

 

Litigation

 

During the first quarter of 2017, we incurred a $30 million expense for a final legal settlement paid to Owens Corning in connection with a breach of contract action related to our termination of an insulation supply contract.  The settlement resulted in the dismissal of the lawsuit filed in May 2016, in Toledo, Ohio.  The settlement is reflected in the significant legal settlement line item within our Consolidated Statements of Operations for the year ended December 31, 2017.  The settlement is also reflected in our Installation segment’s operating results for the year ended December 31, 2017.

 

We are subject to certain claims, charges, litigation, and other proceedings in the ordinary course of our business, including those arising from or related to contractual matters, intellectual property, personal injury, environmental matters, product liability, product recalls, construction defects, insurance coverage, personnel and employment disputes, antitrust, and other matters, including class actions.  We believe we have adequate defenses in these matters, and we do not believe that the ultimate outcome of these matters will have a material adverse effect on us.  However, there is no assurance that we will prevail in any of these pending matters, and we could in the future incur judgments, enter into settlements of claims, or revise our expectations regarding the outcome of these matters, which could materially impact our liquidity and our results of operations.

 

Other Commitments

 

We enter into contracts, which include customary indemnities that are standard for the industries in which we operate.  Such indemnities include, among other things, customer claims against builders for issues relating to our products and workmanship.  In conjunction with divestitures and other transactions, we occasionally provide customary indemnities relating to various items including, among others: the enforceability of trademarks; legal and environmental issues; and asset valuations.  We evaluate the probability that we may incur liabilities under these customary indemnities and appropriately record an estimated liability when deemed probable.

 

We 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 licensing and insurance.  For the year ended December 31, 2018, the outstanding bonds in the table below increased due to the USI acquisition and higher commercial sales activity.

 

The following table summarizes our outstanding performance, licensing, insurance and other bonds, in thousands:

 

 

Liquidity and Capital Resources

 

We have access to liquidity through our cash from operations and available borrowing capacity under our Amended Credit Agreement, which provides for borrowing and/or standby letter of credit issuances of up to $250 million under the Revolving Facility.  For additional information see Item 8. Financial Statements and Supplementary Data – Note 5.  Long-Term Debt.  We believe that our cash flows from operations, combined with our current cash levels and available borrowing capacity, will be adequate to support our ongoing operations and to fund our debt service requirements, capital expenditures, and working capital for at least the next twelve months.  Cash flows are seasonally stronger in the third and fourth quarters as a result of increased new construction activity during those periods.

 

The following table summarizes our total liquidity, in thousands: