Installed Building Products, Inc. (IBP) Q3 2018 Earnings Report, Transcript and Summary

Thank you for standing by. This is the conference operator. Welcome to the Installed Building Products Fiscal 2018 Third Quarter Conference Call. As a reminder all participants are in listen-only mode and the conference is being recorded. After the presentation there will be an opportunity to ask questions. [Operator Instructions] I would now like to turn the conference over to Jason Niswonger, Senior Vice President, Finance and Investor Relations. Please go ahead.

Good morning, and welcome to Installed Building Products third quarter 2018 earnings conference call. Earlier today, we issued a press release on our financial results for the third quarter, which can be found in the Investor Relations section on our website. On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements within the meaning of the federal securities laws. These forward-looking statements include statements with respect to the housing market, our financial and business model, our efforts to manage material inflation, our ability to increase selling prices, our ability to manage employee-related costs, the demand for our services and product offerings, expansion of our national footprint, products and end markets, our ability to capitalize on the new home and commercial construction recovery, our expectations for the residential end markets, our ability to strengthen our market position, our ability to pursue and integrate value-enhancing acquisitions, the impact of Alpha on our revenue and profitability, expansion of our commercial business, the impact of AFT, our growth rates and ability to improve sales and profitability and expectations for demand for our services and our earnings in 2018. Forward-looking statements may generally be identified by the use of words such as anticipate, believe, expect, intend, plan and will or, in each case, their negative or other variations or comparable terminology. These forward-looking statements include all matters that are not historical facts. By their nature, forward-looking statements involve risks and uncertainties because they relate to events and depend on circumstances that may or may not occur in the future. Any forward-looking statements made by management during this call is not a guarantee of future performance, and actual results may differ materially from those expressed in or suggested by the forward-looking statements as a result of various factors, including, without limitation, the factors discussed in the Risk Factors section of the company's annual report on Form 10-K for the year ended December 31, 2017, as the same may be updated from time to time in subsequent filings with the Securities and Exchange Commission. Any forward-looking statements made by management on this call speaks only as of the date hereof. New risks and uncertainties come up from time to time, and it is impossible for the company to predict these events or their effects. The company has no obligation and does not intend to update any forward-looking statements after the date hereof, except as required by federal securities laws. In addition, management uses certain non-GAAP performance measures on this call, such as adjusted EBITDA, adjusted EBITDA margin, adjusted net income and adjusted net income per diluted share, adjusted gross profit and adjusted selling and administrative expenses. You can find a reconciliation of such measures to their nearest GAAP equivalent in the company's earnings release and additional reconciliation for adjusted EBITDA for earlier fiscal years in our investor presentations, which are available on our website. This morning's conference call is hosted by Jeff Edwards, our Chairman and Chief Executive Officer; and Michael Miller, our Chief Financial Officer. I will now turn the call over to Jeff.

Thanks, Jason, and good morning to everyone joining us on today's call. I'm happy to have the opportunity to talk to all of you about our third quarter results. As usual, I will start today's call with some highlights, and then turn the call over to Michael Miller, IBP's CFO, who will discuss our results in more detail before we take your questions. Highlighting our third quarter results are record revenues driven by our geographic presence in many of the country's strongest housing markets and the contribution of recent acquisitions, strong revenue performance at Alpha and price mix growth. In addition, third quarter adjusted net income per diluted share increased 26% to $0.72, which is the second best quarter of adjusted net income per diluted share in IBP's history and the highest ever for a third quarter period. The 18% increase in revenues during the third quarter is a direct result of our continued focus on our growth-oriented strategy. Solid organic growth the contribution of our recent acquisitions and improvements in the rate of single-family housing completions continued to favorably influence revenues. We also experienced strong growth in our end markets during the quarter. Single-family same-branch sales increased nearly 13%, while total single-family sales increased nearly 20% compared to the increase in total U.S. single-family completions of 9.6%. Same-branch multifamily sales increased almost 2%, while total multifamily sales increased approximately 4%. Over the last two years same-branch multifamily sales are up over 100% when compared to Q3 2016. Combined new residential same-branch sales increased over 11%, while total residential sales increased over 17% compared to the increase in total U.S. completions of approximately 5%. During the 2018 third quarter, total U.S. housing permits increased 1.4% with single-family permit growth of approximately 4%. We believe this points to continued growth in our residential end market, and we anticipate that housing will continue to benefit from various factors, including improving employment, rising household formations and strengthening consumer confidence. We continue to believe our focus on operating branches in strong and diverse U.S. housing markets enhances opportunities and creates a favorable position for IBP to outpace industry growth. IBP's current geographic footprint provides us access to nearly 70% of total residential permits. We remain committed to expanding our footprint through acquisitions, organic branch growth and cross-selling opportunities with other product offerings within our existing markets. Diversifying IBP's product mix allows us to provide more installation services to our customers, expand our end markets and deepens our relationships with builders across the country. During the third quarter of 2018, approximately 65% of revenues were derived from insulation installation services, compared to 76% of revenues during the same period in 2014. Expanding our product mix negatively impacts our reported price mix as our other products generally have a lower average selling price per job than installation. However, each of our other products follows the similar supply chain as insulation, where we buy the materials direct from the manufacturer and are delivered, installed by our installers. Historically, IBP was a single-family residential installer of insulation in the Midwest and Northeast. Today, IBP installs a greater number of products, serves multiple end markets and has a larger geographic footprint than ever before, which not only reduces risk but enhances IBP's competitive position. Acquisitions continue to play an important role in both our product and geographic expansion strategies. So far this year, we have acquired approximately $76 million of annual revenues across multiple product lines and markets. During the 2018 third quarter, we completed three acquisitions including Water-Tite Solutions, a provider of commercial waterproofing installation services in the Tampa market with annual revenue of over $6 million. Trademark Roofing & Gutters, a provider of roofing and gutter installation services, primarily to the new residential construction market in Raleigh with annual revenue of approximately $9 million. And Cutting Edge Glass, a provider of glass and glazing systems primarily to the commercial construction market in Denver with annual revenue of over $10 million. Yesterday, we announced the acquisition of Advanced Fiber Technology, or AFT, predominantly a manufacturer of cellulose insulation in Bucyrus, Ohio, with annual revenues of approximately $18 million. AFT is an exciting acquisition for IBP because it provides us with an opportunity to vertically integrate our cellulose insulation supply in certain markets, which we believe will have an immediate and favorable impact on our business and financial results. Like fiberglass, cellulose is an environmentally friendly product and an attractive alternative to fiberglass in a variety of insulation applications. I'm pleased that Doug Leuthold, founder of AFT, will be staying on to assist IBP in running the facility and growing our cellulose supply chain. IBP has a strong platform of complementary businesses managed by experienced leaders. Our product offerings combined with our strong operating cash flow and our expanded credit facility provides IBP with significant resources and capital to continue to fund our accretive acquisition strategy. The market for residential and commercial installation services remains highly fragmented, and our pipeline of potential acquisitions is robust. Given IBP's current stock market valuation and the strength of our balance sheet and cash flow, I'm pleased with the Board's decision to approve a $100 million expansion of our stock repurchase program, which demonstrates our commitment to creating shareholder value and our focused approach on maximizing returns on capital. I'd now like to provide an update on the pricing environment for our installation services and the operational performance at Alpha, our large commercial installation business. In the past, we have talked about the complex pricing and demand dynamics within the insulation industry throughout the year. The increased demand for material to support industry growth as well as planned and unplanned downtime at manufacturing facilities have impacted industry supply and supported manufacturer price increase strategies in 2018. We responded to these industry pricing trends by increasing prices and experienced price mix growth of 4.2% in the third quarter. Unfortunately, we were impacted by additional material price increases, which we weren't able to offset with selling price increases during the quarter. Overall, higher material costs impacted third quarter gross margin by approximately $4.5 million. Without this inflationary headwind, same-branch incremental adjusted EBITDA margins would have been in line with our expected range of 20% to 25%. In addition, certain manufacturers recently announced that further increases will occur in the coming months. We are proactively working with our customers and suppliers to lessen the impact of rising material cost across all product lines. We expect that it might take a few quarters for IBP to fully address the current pricing environment, and we continue to believe our financial model can achieve annual incremental adjusted EBITDA margins of 20% to 25% once we work through this period of material inflation. Throughout the remainder of 2018 and 2019, we are putting a greater emphasis on our branch managers to align with customers that want partners like IBP who can deliver quality installation services on time and at a fair price. We expect this alignment to enable us to better manage periods of material inflation, improve our labor utilization and drive margin expansion across each of our product categories. Turning to Alpha, as we mentioned in our second quarter call, gross profit in our large commercial construction end market was negatively impacted by costs associated to support new locations and meet customer production schedules. I'm happy to report that profitability stabilized during the third quarter as sales increased and operating expenses to support these locations improved. As these trends continue, we expect profitability at these new branch locations to show further improvements in 2019. To wrap up my comments before turning the call over to Michael, 2018 is shaping up to be a record year for both sales and profitability. While we have been diligently working to navigate several macro-level challenges this year, we're a stronger company today than at any point in our history. We'll continue executing our strategic growth plan, while deploying our strong operating cash flow to make strategic acquisitions, invest in our business and repurchase stock. I'm excited about our future and the opportunities we have to create value for our shareholders. I would now like to turn the call over to Michael to provide more details on our third quarter results.

Thank you, Jeff, and good morning, everyone. For the 2018 third quarter, our revenue increased 18.2% to a record $349 million. Our same-branch sales increased 12.2% due to an increase in volume and favorable improvements in price and mix. Our same-branch single-family sales growth was 12.9% and our total new residential construction same-branch sales increased 11.3%. Third quarter 2018 gross profit improved 13.7% to $97.3 million from $85.6 million in the prior year quarter. Adjusted gross profit as a percent of revenue was 27.9% compared to 29.2% in the same period last year. As Jeff mentioned, the decline in gross profit margin was predominately attributable to material inflation, which impacted gross profit by approximately $4.5 million. I'm pleased to report on the labor side of cost of goods sold, we have experienced lower turnover and better retention and productivity rates. These improvements are a direct result of the investments we have been making to attract, retain and motivate our workforce, and we will continue investing in our employee benefit programs. For the 2018 third quarter, selling and administrative expenses as a percent of net revenue improved to 18.8% as compared to 19.1% for the 2017 period. As a percentage of revenues, the administrative expenses were 13.9% in the third quarter compared to 14.1% for the same period last year. Adjusted selling and administrative expenses as a percent of net revenue improved by 60 basis points from 18.3% to 17.7%. We expect selling and administrative expenses as a percent of net revenue to continue to improve over time as we further scale our operations and benefit from increased sales. As we have stated in previous earnings calls, it is important to note that as our acquisition strategy continues and as the volume of total acquired business operations become larger, we will incur additional noncash amortization expense. In the third quarter, we recorded $5.2 million of amortization expenses compared to $6.8 million for the same period last year. This non-cash adjustment impacts net income, which is why we continue to believe that adjusted EBITDA is the most useful measure of profitability. Based on our acquisitions completed prior to AFT, we expect fourth quarter and full year 2018 amortization expense of approximately $5.4 million and $25.1 million, respectively. These figures will change with any subsequent acquisitions. The third quarter of 2018 adjusted EBITDA improved to $43.8 million, representing an increase of 11.2% from $39.3 million in the prior year. As a percent of net revenue, our adjusted EBITDA was 12.5% in the third quarter compared to 13.3% in the prior year quarter. We continue to believe our financial model can return to full year mid-teens adjusted EBITDA margin as the housing recovery reaches stabilization. Our same-branch incremental adjusted EBITDA margin for the 2018 third quarter was 7.4% compared to 15.9% for the same period last year. Adjusting same-branch incremental EBITDA with the impact of material inflation on margin, IBP would have achieved a same-branch incremental adjusted EBITDA margin of approximately 20% for the 2018 third quarter. As Jeff mentioned, it may take a few quarters for IBP to fully address the current pricing environment. We continue to believe our financial model can achieve annual incremental adjusted EBITDA margins of 20% to 25% once we work through this period of material inflation. On a GAAP basis, our third quarter net income was $15.6 million or $0.50 per diluted share, compared to net income of $12 million or $0.38 per diluted share in the prior year quarter. Our adjusted net income improved to $22.4 million or $0.72 per diluted share, compared to $18.3 million or $0.57 per diluted share in the prior year quarter. For the third quarter of 2018, our effective tax rate was approximately 25.6% compared to 32.3% in the prior year quarter. For the 2018 full year, we expect an effective tax rate of 25% to 27%. Now moving on to our balance sheet and cash flow. For the nine month period ending September 30, 2018, we generated $68.8 million in cash flow from operations compared to $53.3 million in the prior year. We continue to use our strong operating cash flow to fund acquisitions and reinvest in our business. Capital expenditures at September 30, 2018, were $27.1 million, while total incurred capital leases were $1 million. Capital expenditures and incurred capital leases as a percent of revenue decreased 30 basis points to 2.9% at September 30, 2018, compared to the same period last year. We continue to expect gross capital expenditures and incurred capital leases to trend at approximately 3% of sales during this part of the housing recovery. At September 30, 2018, we had total cash and short-term investments of $154.4 million compared to $92.6 million at December 31, 2017. During the third quarter, IBP repurchased approximately 381,000 shares of our common stock and year-to-date, we have repurchased approximately 793,000 shares. Under the newly expanded stock repurchase program, we have $107 million available in our expanded $150 million stock repurchase program. Total debt at September 30, 2018 was approximately $465 million. Taking into account cash and short-term investments at September 30, 2018, our net total debt was approximately $311 million compared to $267 million at December 31, 2017. Our capital structure remains conservative, and we have considerable flexibility as we continue to deliver on our growth strategy. With that, I will now turn the call back to Jeff for closing remarks.

Thanks, Michael. IBP has a strong platform, a disciplined approach and an experienced team. I continue to be encouraged by our record results and our opportunities to grow and create value for our stockholders in 2018 and beyond. Operator, let's open up the call for questions.

Certainly. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Michael Wood with Nomura Instinet. Please go ahead.

Hi. This is Mason Marion on for Mike. Just starting -- so it's been almost two years since you've consistently met your long-term 20% to 25% same-branch leverage goal. Is there anything you are or can do today, such as a restructuring in order to get incrementals back within this target? And should we interpret your comments that material inflation will continue to be a headwind for several more quarters to imply that 2019 will be a struggle to reach that long-term goal?

Hey, Mason, this is Michael Miller. Thanks for the question. Yes, so we did indicate in the comments that we think that pricing is -- the pricing environment is going to continue to be challenging. In terms of getting back to the 20% to 25% incremental margins, it is not a question of restructuring our cost. We think we've been doing a pretty good job on the cost structure with the exception, obviously, of the inflation headwinds that we've been facing. It really is a question of price, not even volume. As you've seen by the numbers that we disclosed today, our volumes are still very strong. It's really about working with our customers to continue to get higher pricing and that will continue to drive profitability and get us back, we believe, to the 20% to 25% full year incremental margins.

Okay. And then the price mix helped you exceed single-family completions during the quarter, but in terms of volumes, you trailed completions. Can you elaborate on why you think organic volumes lagged the market growth? And do you expect this trend to continue going forward?

There are a lot of things that influenced the volume growth. And it is not necessarily a direct correlation with the completions growth, because when we're looking at completions, we're looking at total U.S. housing completions versus completions just in the markets that we serve. So there can be a mix where markets where we're underpenetrated or not and can have higher levels of completions growth than the markets that we're in. When we look at our kind of sales per permit in our markets, we feel very good about the growth rates that we're seeing relative to the permits in our markets. So we feel confident with -- and good about the kind of the volume levels that we are. But really, for us, this is not a volume game. It's about -- right now it's about working with customers that are willing to pay us a fair price for the high-quality service that we're providing them.

Great, thank you.

Our next question comes from Nishu Sood with Deutsche Bank. Please go ahead.

Thank you. Yes, I also wanted to ask about the price cost question. The couple of quarters statement, I just wanted to understand what that assumes. Does that assume that pricing stabilizes here and then it will take a couple quarters to get the incremental margins back up to normalized? Or does it assume that as prices continue -- even if they continue to rise that a couple quarters from now, the flow-through of the business should show through? I guess, what's underlying my question is, is it possible to get back to the normalized incrementals of 20% to 25% in a continuously rising price environment for the materials?

Thanks, Nishu, for the question. It is difficult in a continuously rising price environment to get on top of it, but we believe once we get on top of it, we will be clearly back in that 20% to 25% range, and we do start to get some benefit associated with getting on top of it. But it is difficult in a rising price environment, particularly the environment that we experienced in 2018 where it was particularly exacerbated by the fact that you had three material price increases that stuck to a decent amount within the market back-to-back like that. We haven't experienced something like that in -- since the last 2005, 2006. So it really was an unprecedented level, both in number and in amount, of price increases that we experienced in 2018. We believe in 2019 that while we will still have a rising price environment, it will not be as tough as 2018 has been and that'll give us the ability to get on top of it, and eventually, get back to that 20% to 25% incremental margin on the existing business.

Nishu, this is Jeff -- it's Jeff Edwards that is, Jeff Hire is in room too, but the idea is -- to stress the point again, the idea that it was three in a year is what made it so difficult because, basically, the spread of time between the three increases and what it takes for us to get with our customers and work with them, and that's just -- it's too many to get on top of kind of in a normal way. Jeff Hire has confirmed, I think, the last time was 2005, but really, in 31 years of history with Owens Corning and nine years of history with us, this is only two times in history that, that's even happened.

Got it. So your couple of quarters statement then, if I could just summarize, assumes that there may be further price increase in the next couple of quarters, but not at the pace of what we saw so far in 2018?

As you probably know, the manufacturers are already out with an increase in January, so that's three or four.

Got it. Okay, got you. And so we appreciate the thoughts and the details around that. The other concern, I'm sure as you're aware is about housing slowing. You have always laid out very clearly that you benchmark your volume growth against completions growth, not against something earlier stage, but clearly, completions are the end of the construction process. In your order book of business or inquiries, your dialogues with customers, are you seeing any signs of slowing volumes at the front-end of your sales process versus what's recognized when it's finally booked as revenues?

We are not, Nishu, seeing any slowdown right now. I mean, clearly the macro data has been weaker than people have expected. We believe, though, when you look at some of the data that is not frequently highlighted like ADAC loan growth, what the builders are talking about in terms of community count growth, land spend that you're seeing on the builders' side, we think that those are all encouraging signs that would point to continued growth in, particularly, the single-family market as we go into 2019. Admittedly, there is slower growth right now that the macro data is highlighting, but we think there's strong reason to have confidence that you have good growth in the single-family side and growth in the single-family side going into 2019, coupled with what we think is a little bit more favorable backdrop on the multi-family side than what most people expect, particularly when you look at, again, kind of financing availability for multifamily projects and that there is certainly a demand for housing. And we think that there is reason to be very encouraged about what 2019 looks like for the housing market despite sort of people's feelings and some of the macro data that's came out recently.

Okay, thank you.

Our next question comes from Susan Maklari with Credit Suisse. Please go ahead.

Thank you. Good morning.

Good morning, Susan.

My first question is -- I think it was Jeff said in his comments made a -- said that you're putting greater emphasis on your branch managers to kind of align with your customers and get some of this pricing through. Can you just give us a little bit more color on what that involves? How are you giving the branch managers the ability to get some of this inflation through, and yet, do it so that you're holding those margins versus volumes in there? Is there anything that's different than what you've done in the past?

I would say that it's kind of more of a macroscopic focus, even down to the salesperson level. So I don't know that our message to say our regional presence is any different. But I think the pushdown from them and the flow-through through them to managers and even ultimately the salespeople, that effort has been heightened really greatly -- I mean, it's not -- as Michael mentioned earlier, we do not have a volume problem. I mean, we are busy. We have more sales, frankly -- as you know or as you might guess, we'd rather have higher margins and a little lower sales, and everybody, including ourselves will be a lot more happy with that. So it's really just a heightened focus on a lot of the things that we do. I mean, as you might guess from a salesperson comp perspective -- I will not talk about that, right. So we have kind of a margin regulator around our commission schedules with most probably our salespeople. At the same time, if you're a salespeople and you're asked -- I'm just giving a little dose, I guess, of the reality that the salespeople face. But if you're a salesperson ask -- and you're asked to go out and get a very serious price increase from one of your very large customers, at least in terms of that salesperson's large customers, that's a difficult thing to do when you have bills to pay, if you know what I mean, because there is a chance that customer won't be there. So we're working on creative ways to make sure that whatever message we've delivered to the salespeople, they feel comfortable and confident about going out and getting the price increased and that it won't necessarily impact them immediately in their pocket books. So we're just -- under any circumstance, we're trying to push that and get prices up.

Got you. Okay, that's helpful. And then my next question is on AFT. I mean, this is obviously a change in your strategy. You're kind of going more backwardly integrated with this. Can you just talk to what drove the decision? How we should think about the growth of this business going forward? Are there certain markets or geographies that you want to bring this into over time? And how should we think about it flowing through your business and your results?

Hi, Susan, this is Jeff again. So this -- it may be a little known fact, but we have really for years and years and years had a operation in Shelbyville, Indiana, and at one point in time, we had one outside of Newark, Ohio, that -- where we processed scrapped fiberglass into our own blowing wool. It was a fairly significant -- if you look back at it historically, actually before the downturn, it was a fairly significant portion of our blowing wool material supply. And while AFT is not a material portion of either our entire blowing wool, or let's say, loose-fill insulation needs, and while AFT is not, even though they're currently a small supplier to us of cellulose, they're not a large component of our overt cellulose need. But what I think I can say is that in times of tight supply, for us to be in control a little more of our -- the product side of things, that has served us well. On a go-forward basis, we would plan -- one of the interesting things lately is that cellulose at one point in time, not too long ago, as most of the paper was being bought overseas, had become very expensive compared to fiberglass blowing wool. That has changed to a degree with some of that demand outside of the U.S. waning a great deal. So it puts us just in an interesting position to try to continue to grow that business a little bit, but to do so to a degree inside of our own footprint and inside of our own branches. So we're really pretty excited about it. The gentleman we bought the business from is an engineer and has an engineering background and actually was in the -- prior to the cellulose business, in the equipment manufacturing business and kind of laying out plants and helping others get into this business. So we'll see where it leads. But clearly, there are some parts of the country where we use a lot of cellulose, and we'll see what opportunities that presents to us.

Got you. Okay, thank you.

Our next question comes from Trey Morrish with Evercore ISI. Please go ahead.

Thanks, guys. I was wondering if you could talk about the $4.5 million of high material cost that you highlighted in the quarter, was that a gross number or net of pricing? And secondly, if theoretically there were no more price increases, how long do you think it would take you to fully cover that inflation?

Trey, this is Michael. So that's a net price, not a gross price. And it's -- as you know, we don't provide guidance, but part of the -- as we were talking earlier, is that we had these three price increases and one of them was announced and took effect basically in September. And so there is still -- even if there were no price increases it's going to take several quarters to realize the benefit of higher prices to offset that simply because of the magnitude of the number and percentage increase that we've experienced over the course of the year. But as we've said, we are making it our top priority. And we are not looking for volume, we are looking for price. And we are working closely with our customers to -- we have the labor to get the jobs done on time, the quality labor to get the jobs done on time. We've improved significantly our labor efficiencies and our labor turnover. And all those things help provide for us to be a high-quality installer for our customers, and as a consequence, we think it's appropriate that they pay us a fair price for that high-quality service and we just need to get on top of it.

Okay, thanks. And then regarding the repurchase authorization, do you imagine that would be used more opportunistically or in a more kind of programmatic nature? And how do you view weighing the $100 million of authorization you've just given relative to potential future M&A activity?

We'll use it opportunistically, but in a thematic way, so a very -- as consistently as possible because we think that's an appropriate use of capital right now. Fortunately, as you know, the business generates quite a bit of free cash flow. So we feel confident given where we are currently with the balance sheet and our ability to generate free cash flow that we have the ability to both maintain a fairly aggressive stock repurchase plan as well as our -- continue our acquisition strategy and momentum that we've had.

Thanks very much, guys.

Our next question comes from Mike Eisen with RBC Capital Markets. Please go ahead.

Good morning. Thank you for taking my questions. I just wanted to start off on the commercial side of the business. Last quarter, there was a lot of discussion around some of your greenfield branches and how much time it would take for those to ramp up and become fully operational and effective. Can you give us an update on that because it seems to be have happened at a faster pace than we'd have expected and just more so broadly on the commercial market in general?

Yes. So the commercial business is improving at a faster rate than, which obviously pleases us, than we probably indicated in the call last quarter. We don't think we've made it -- we haven't gotten completely to where we want to be, but that business has definitely shown good signs of improvement in the third quarter. And a part of -- a big part of the improvement is, yes, we're stabilizing the greenfield operations, but also, the -- what I'll call, the legacy operations performed well in the quarter as well. We continue to develop a very good backlog in that business with what we believe are margins that are acceptable and consistent with what our expectations would be for that business, and the incremental margins in that business are consistent in that 20% to 25% range right now. So we feel good about the performance that we had in the third quarter with that business. And we continue to see it as an important part of our strategy to diversify our end products and customer mix.

Understood. That's really helpful. And then thinking more so on your various gross -- growth initiatives, when we're thinking about balancing the step in the vertical integration, the greenfields on the commercial side and more M&A in the residential, is there any change in the balance of capital allocation you guys are putting towards those? Or where we should expect to see M&A moving forward?

No. I mean, the amount of money we spend on AFT is not, obviously, inconsequential, but in the scheme of things, based on kind of our normal play in terms of our acquisition growth and even our organic growth, it's really not meaningful.

Yes. And I think it's all on a relative basis, when you think about it, as a company, as we continue to grow and improve our free cash flow, those investment dollars will continue to increase, but in relationship to our free cash flow and our other investments. So we feel very comfortable about being able to allocate capital in multiple directions.

And I guess, I should correct what I said. I didn't mean to imply -- we didn't disclose the terms of the deals around AFT, but the revenues were $18 million and I guess, the consequence it's still inconsequential in the scheme of things when you look at our acquisition pace and our continued desires to grow other products and to grow our footprint.

Yes, interestingly, as a result of our strategy to grow other products during the quarter, our insulations, so fiberglass and spray foam sales increased approximately 15%, while our other product sales grew 24% in the quarter. So we're seeing good penetration with those products.

Understood. That’s really helpful. Thank you, guys.

Our next question comes from Phil Ng with Jefferies Group. Please go ahead.

Hi. This is actually Collin on for Phil. So just a quick question on the pricing. Has your conversations with your customer changed at all just because they're also facing a fair amount of inflation outside of just the fiberglass inflation cost?

Well, it has. It's been accelerated in terms of continuing to get more price. Unfortunately, as we've noted, it's been three conversations this year as opposed to one conversation, which is always a little bit more difficult. I do think it is helpful that they're seeing relief, and I think most people would expect that they're going to continue to see relief on the lumber side which as you know is a much larger percentage of the cost of construction than the products that we install. So while the builders clearly don't want to take price increases on products, where we need to do a better job of quite frankly, is differentiating the customers that are willing to value our ability to show up on time, complete the job accurately the first time and not slow down the cadence of them building the house. And we just need to continuously strive and work harder to work more closely with those customers because they value the service that we bring as a company.

Great, thank you. And then just with some of the manufacturers idled capacity coming up, does that give you a better leverage with your suppliers whether it's pricing, the timing of the implementation of the increases or your -- the ability for you guys to build some inventory ahead of the price increases?

Yes. And it's -- as you know, in the fiberglass side of the business, they're not really seeing -- other than on the shipping, trucking side, they're not seeing inflation on their product cost. It's a high fixed cost business. It's basically sand and a little bit of chemicals and energy. And when they're pushing price, it's not because they're experiencing inflationary pressures on their side of the business. It is a supply and demand environment. So to the extent that more supply comes online, it obviously creates a better opportunity from a leverage perspective for us but, at the same time, we would say, which is a different than a lot of opinions that people have right now we realize, but we believe that demand is going to be good in 2019 and it'll still continue to be supportive of pricing momentum from the supply-demand perspective from the manufacturers and we believe from us as well with our customers.

Great, thank you for the color.

Our next question comes from Keith Hughes with SunTrust. Please go ahead.

Hi. This is Josh Large on for Keith. So some two quick questions. You've talked about the multiple price increases in fiberglass over the year. Have you seen similar increases in spray foam and mineral fiber? And are they any easier to pass along?

On the spray foam side, no, we've not seen the same kind of price material inflation that we have on the fiberglass side, but we have experienced price inflation on the other products that we install as well. So with the exception of spray foam, there has been material price inflation in all of our product categories. It's just been the most pronounced and sticky, and the number of increases have been greater on the fiberglass insulation side.

Okay, great. Then following up on some AFT questions, could you elaborate a little bit on the end market exposure for the business?

So about 80% of it is -- approximately 80% of it is residential construction, with a high component of it being repair and remodel versus new construction because the repair and remodel side -- historically, cellulose has been -- has had a higher share of repair and remodel work because it's driven by energy programs because it's the...

Sponsored by utilities primarily a lot of times.

And it is considered to be a very green product because it is using recycled paper. So their business tends to be a little bit weighted on the residential construction side towards repair and remodel. The other 20% is industrial fibers. So it's a mix.

Okay, great. That’s it for me.

Our next question comes from Ken Zener with KeyBanc. Please go ahead.

Good morning, gentlemen.

Good morning.

So you guys have seen a lot of cycles. I know you referred to the three prices that made it hard to constantly go back and have the line set appropriately. Looking back, I guess, I mean, given your experience, I mean, it's not unprecedented of fire that happened. Was it really just the velocity of these price increases that kind of got you? And is there something, one, is it a tolerable number because you guys have been pretty -- a year ago pretty strongly worded that you can get price, right? So it's good that commercial headwinds are fading. But I mean, if you had two price increases, would you be in the same situation as you're now? Or is it really just that third one that pushed you over...

Ken, this is Jeff. I don't -- I think if it was two price increases the way they normally come out, first part of the year, middle part of the year as they have been announced in the past and as is probably more normal, we would not have been -- we would not be in this particular situation. It's really both the velocity and the speed and a little bit of the magnitude coupled with. And we've said this before, the idea that there had been many previously announced price increases going back 36, even probably, this is off top of my head but even 42 months and kind of proceeding up to 2018, where there wasn't that degree of traction because of a number of reasons including the failure and the meltdown of the furnace in Richmond at JM's plant. And so they kind of all came -- all those things came together to kind of put what was a surprising amount of rigor behind that, and then it was an education for us in terms of our organization to tell our group that, get ready, we'll increase, they're so used to seeing the other ones, whether that's a salesperson or whether that was a manager, it just the -- it took a while for the reality to set in.

And I just kind of ask -- I mean, is it, understanding what you just said, is there something about when you're making all these bids, right? I mean, there's you're making enormous amount of bids each day. Is there something about price happening at this time of the year that perhaps made it a little more difficult because builders themselves realizing you have like large and small builders in your portfolio, but is there something about kind of the year-end if you're looking at these projects that you're closing, is there something about how they had their budgeting scheduled that made them more resistant to accepting price or is there a change there?

I mean, as you know, as we come into, particularly, August, September, October, it is the busy season because we're doing work on the houses that were sold during the spring selling season to some extent. And it's fairly common within the industry that you will protect a house that's already been sold and those houses were sold in the spring selling season long before we had complete knowledge around where the year would end up from a price increase perspective. So yes, I would say generally speaking, it's a little bit more difficult just because of the volumes. But at the same time when the volumes are high, it's the best opportunity for us to get price increases. So we need to -- as we've said on the call we need to work as closely as we can with our customers to make sure we're working with the customers that are paying us a price that values the level of service that we bring to them.

Thank you very much.

Sure.

[Operator Instructions] Our next question comes from Matt McCall with Seaport Global Securities. Please go ahead.

Thank you. Good morning, everybody.

Good morning, Matt.

So maybe I want to talk about mix a second. So when we look at price mix in the quarter, it was up 4.2% year-over-year, deceleration from last quarter, but I assume there's more price on year-over-year basis because we've had incremental price increases. So is there something going on, on the mix front that we need to keep in mind as we're modeling that specific driver going forward?

Yes. I mean, as we've said, the average, and I think this was in Jeff's prepared remarks, I mean, clearly as we continue to diversify, which we think is the right decision to diversify and get outsized increase in other product sales that will influence price mix down because the other product sales tend to have a lower average dollar job price. So it definitely influences price mix. So -- and another thing that influences price mix as well is where we're seeing growth and the size of the houses that are being built. So there are a lot of things that influence it, but we feel we as -- I think, as we've clearly stated sort of in this call, we definitely are working very hard to improve our pricing with our customers. And we think over time that obviously benefits price mix with the recognition that when we see growth of 24% in other products, it negatively impacts the price mix equation.

Okay. So I guess, a similar question on the gross margin and profit side. Adjusted for the $4.5 million of price cost drag, and it looks like gross margin was flat to down-ish slightly on a year-over-year basis, was there -- is that also related to that mix issue you're talking about? Or something is going on there beyond price cost that would impact gross margin?

The mix can influence gross margin because, as you know those other products have a tendency to have slightly lower margins than we have in the insulation business. But overall we believe they have good incrementally the down margins because they get good SG&A leverage as a consequence. So they can negatively impact gross margin, but really the key for us to continue to improve gross margin over time is the selling price issue that we've been talking about. I mean, that is the real driver. And when we talk about selling price, we're not talking about it just with fiberglass, we're talking about it on all of our products, right, because as we said earlier, we've seen material price inflation, with the exception of spray foam, on all of our products.

And actually, that's my -- it is my third question. So the -- you mentioned a few times you want to make sure that you're getting paid for your service. And I assume that means that folks are unwilling to -- or you've seen instances where folks are unwilling to pay for it and that implies they're going elsewhere. Q -But has the competitive behavior changed as we progress through the year? I assume that maybe some folks would ignore the first one. You said there had to be that kind of reeducation period early in the year, but has the competitive behavior changed as we've gone from 1 price increase to two price increase, it is now to three and then another one already being announced. Have you seen a change there that may help your pricing recognition?

Well, so when you say has the -- are you asking whether our attempt to compete, we've changed our competitive stance or are you asking whether our competitors have changed their stance?

Yes. I'm asking did you see some competitors behaving badly, and therefore that made your pricing efforts more difficult and maybe that's getting better since we're seeing now three and four price increases being announced?

Yes. I think as the market continues to realize that these price increases are there, they're sticking and that the price is going up and that there's probably going to be a higher pricing as well going into 2019, legitimately, they have to raise prices as well. But despite that we have to continue to work at the local level to make sure that we're working with the right customers that again, are going to value the service that we're providing.

Yes, I wouldn't -- but I would not blame the competitive situation or competitive environment on -- this was three price increases of magnitude. And clearly we're in this business for the long haul, we do work with our customers, let's face it. The customer's job is to be on one side of a price negotiation and our job is to be on the other side of that negotiation. And so it's a matter of meeting of the minds that something that works for both parties, we are dead fast set on getting our price increases, though, whether that results in not doing some business with certain customers on certain accounts in certain markets, that's probably absolutely the case. And that's to Michael's earlier point, just a matter of us deciding that we're not being paid what we're worth. There's plenty of work in the market. And if they want to have somebody else do the work, that's okay. It's just -- it's their prerogative and it's ours, I guess. It's the American way, the American economy, I guess, that works, right.

True.

Okay. All right. Thank you, guys.

Our next question comes from Justin Speer with Zelman & Associates. Please go ahead.

Thanks, guys. Jeff, Mike appreciate the time. I just wanted to -- I had a few questions for you. One, just rewinding -- I know there's been a lot of this -- the cadence of the price increases has been pretty successive and dramatic and it's not just for you but for a lot of folks. So I realize that -- I recognize that's just -- like tough to graduate that all through. But the price increases were out there in August, September, that third increase was already out there last quarter when we were talking about this, and I'm guessing that's more of a factor for the fourth quarter. As for this quarter, is it in terms of your transmission of those prices through the builder channel? Or are you trying to tell us that's just more challenging in light of the current environment than you appreciated? Or is it more of an internal thing? Is it more challenging from the standpoint of that just the reality of dealing with that type of customer base and takes time to get it through or is it something internal?

It's not something internal. It's definitely just the challenge of the multiple price increases. And I think, as you know, just because of price increase -- unfortunately, because there are -- I mean, a good thing about our business is there is no transparency into the price, but sometimes that can be frustrating because what happens is that even though the manufacturers announce a price increase, we don't know sometimes until 60, 90 days, believe it or not after that price increase goes into effect, as to what's actually going to stick in the market, right. So there's a lot of moving pieces and there's a lot of uncertainty, if you will around just what the price increase is going to ultimately mean to the market. And what we're focusing on is getting that entail as quickly as we can and making sure that we're pricing to what we believe the market is going to be as quickly as possible. But when you have three price increases in a year, it just makes it more difficult.

That makes sense. And just a big picture thinking about the -- what's being telegraphed by the public builders, order trends, this deceleration in order activity, which leads you by a couple quarters, probably, I'm thinking about that transmitting through your volumes. Thinking about a flattish macro kind of order cadence or volume cadence for you, and then thinking about the prospects for further manufacturing price increases, are there anything beyond pricing that you can do, any leverage you can pull to be -- to harbor some efficiencies here in the near term?

Yes, absolutely. In that kind of an environment, we believe one of the best strategies and it's a strategy that we used during the last downturn to great effect, is to do two things: one, increase the cross-sell of the other products because we get great lift from the SG&A perspective as the branches continue to increase the sales of those products with their existing customers, and it also makes those customers stickier with us because we're doing more products with them, and then also, expand our service area. When business is as strong as it is right now and volumes are as good as they are we have a tendency not to drive -- we have a tendency to keep the cluster of work that we do closer to our locations. When we're in a flattish to declining environment, we will expand the geographies that we'll do work in and that while it is more expensive from a fuel perspective, it provides a great environment for us to maintain a good base of business and a good book of business in that environment. Fundamentally though, we would agree with a view that a lot of analysts still have is that while there is this pause that's out there in the market right now that when you look at again the ADAC loan growth, when you look at land spend of the builders and the community count growth that's coming, there -- and it's going to take time, but it's clear that they are aggressively working to make a shift towards more affordable housing and that there continues to be strong desire among the millennials to own homes. And we believe, fundamentally as Jeff just said, we're building this business and we're here for the long term. We're not doing it quarter to quarter. We believe in the long term. Fundamentally, the backdrop is still very strong for the single-family and even the multifamily housing market.

Excellent. And thinking on this commercial piece of the business like the cellulose, if you can give us a bit of a market definition there, what -- how much of your costs -- how much of your sales are cellulose based? And also what the market definition is. And then lastly, what you paid for the earnings stream there? What kind of margin structure are you talking about for this business and what you paid for it?

Well, on the last question there we haven't disclosed that yet. So -- but on the two other questions to give you a sense, loose-fill makes up about 40%, 45% of our overall fiberglass insulation sales. And of our loose-fill purchases, about 8% is cellulose.

Okay. And I guess, thinking about this, the commercial piece of the business that you're -- you've begun with the Alpha acquisition, thinking about some of the unevenness that we've seen there and then maybe some of this verticality just making sure we get a good handle on your command of these other kind of businesses or maybe a little further afield from your core wheelhouse. If this is something that in terms of these businesses, we should think about them growing in size for your business, but maybe whines a range of potential outcomes just because it's a little bit newer in the portfolio is that fair to think about it that way?

Honestly, I mean, Alpha was obviously a large transaction and it runs between 9% to 10% of our overall revenue. But the AFT transaction is only about $18 million in revenue. So it is not for a company our size it's not significant, but we do think that it has the ability. As Jeff said earlier, it has the ability for us to control a little bit more of our loose-fill supply, which is the tightest part of the material market right now, and it presents a very interesting opportunity for us. And it is not that far afield for us. We have manufacturing facilities currently, we have a larger manufacturing facility that did a similar process that they did. So this is not as -- out of our wheelhouse as it might look because we don't spend a lot of time talking about, as Jeff said, our facility in Shelbyville, Indiana, because it's just like the AFT transaction, it's not material.

And on the commercial side, that business actually after you get over the hump of opening these many locations as we did, that business has a greater degree of predictability, at least over a longer -- much longer period of time based on the kind of the length that those projects take when you bid them in the backlog. So it actually is kind of more steady, I guess, in a good economy than -- at least as steady, let's say, as the residential business. You get a lot more insight into your actual future revenues.

That’s good color. Thank you both for your time. Appreciate it.

This concludes the question-and-answer session. I would now like to turn the conference back over to Jeff Edwards for any closing remarks.

I'd like to thank all of you for your questions. And I look forward to our next quarterly call. Thank you.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.