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TopBuild Corp
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Greetings. And welcome to TopBuild's Third Quarter 2022 Earnings Call and Webcast. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded.
I will now turn the conference over to Tabitha Zane, Vice President, Investor Relations. Thank you. You may begin.
Thank you, and good morning. On the call today are Robert Buck, President and Chief Executive Officer; and Rob Kuhns, Chief Financial Officer. We have posted senior management's formal remarks and a PowerPoint presentation that summarizes our comments on our website at topbuild.com.
Many of our remarks will include forward-looking statements, which are subject to known and unknown risks and uncertainties, including those set forth in this morning's press release, as well as in the company's filings with the SEC. The company assumes no obligation to update or supplement forward-looking statements that become untrue because of subsequent events. Please note that some of the financial measures to be discussed on this call will be on a non-GAAP basis. The non-GAAP measures are not intended to be considered in isolation, or as a substitute for results prepared in accordance with GAAP. We have provided a reconciliation of these financial measures to the most comparable GAAP measures in a table included in today's press release, and in our first quarter presentation, which can also be found on our website.
I will now turn the call over to Robert Buck.
Good morning, and thank you for joining us today. Our third quarter financial results reflect the strength of our operating model and our continuing focus on improving our operational efficiency.
Revenue increased 53.8%, 22.6% on a same branch basis, and adjusted EBITDA margins improved at both business segments. On the installation side, our volume continues to outpace completions as trades and supply chains ahead of us show improvements, accelerating our ability to work through the housing backlog. In addition, our commercial business, both heavy and light, is steadily improving. This resulted in third quarter installation revenue growing 27.8%, 26.1% on a same branch basis. Our Specialty Distribution segment on a same branch basis grew revenue 18.7% driven by strong execution and improved volume. We saw solid demand from the commercial and industrial end markets as new projects came online.
Our results are a testament of the hard work and dedication of our TopBuild employees and their continued focus on driving operational efficiencies and executing well in the evolving economic environment.
Switching to Distribution International, it's been just over a year since we closed on this acquisition, providing us with a direct entry and leadership position in a highly attractive and growing $5 billion mechanical insulation business. While the talented team, projected synergies and strong growth opportunities were obviously critical factors in our initial valuation of DI, we are also attracted by the opportunity to enter a new insulation end market, industrial and increase our penetration in the commercial end market, both of which operate on a different cycle than residential housing.
The integration of this $1 billion acquisition is going extremely well, with most branches now on our ERP system and supply chains optimize. In addition, we continue to identify opportunities to streamline operations through our specialty distribution network by leveraging technologies and best practices. As projected, we have met our goal of achieving run rate cost savings of between $17 million and $20 million in the first year of ownership, and we are highly confident we will meet and likely exceed total cost savings of between $35 million to $40 million by October of next year, at the very latest.
DI's financial performance has also exceeded our expectations, in part due to large-scale commercial and industrial construction and maintenance projects no longer delayed due to the pandemic. The DI team has done an outstanding job managing the business and working hand in hand with our other operational leaders to identify growth opportunities across our North American branch network.
We are pleased to see our commercial business in both segments, Installation and Specialty Distribution, improving, and we're optimistic our commercial business will continue to demonstrate positive growth, both organically and through targeted acquisitions. Our outlook is based not only on our own bidding activity and backlog, but also on year-to-date nonresidential construction data, which points to resurgence in demand. However, we also acknowledge there's still much uncertainty, with labor and supply chain constraints continue to hamper industry growth, and higher interest rates possibly putting some projects on the back burner next year.
Turning to material. Fiberglass remains on allocation. Despite signs of a housing slowdown, inflation in our industry has not abated, as evidenced by the fact that all four fiberglass manufacturers have announced a 10% cost increase effective either in December or early January. On the other side of the equation, builders are seeing a slowdown in orders and beginning to push back on price in general. While this has created an unprecedented situation in our industry, we will continue to strive to strike the optimal balance and timing market by market between price and volume.
Moving to M&A. We completed one small acquisition this quarter and year-to-date have completed five, all of which are residential and light commercial installation companies. In total, these firms are expected to generate over $17 million in annual revenue. The highly fragmented nature of our three end markets provides us with solid opportunities to continue to execute our acquisition strategy on both installation and distribution side of our business.
We are steadfast in our belief that acquisitions are the best use of our capital and will generate the strongest returns for our shareholders in both the near and long term. With the successful integration of DI mostly behind us, our team is focused on building and working a robust pipeline of targeted acquisitions. In the third quarter, we also returned capital to our shareholders by repurchasing almost 270,000 shares at an average price of $185.50 per share, returning approximately $50 million to our shareholders. Year-to-date, we've repurchased slightly over 1 million shares, returning $200 million to our shareholders.
On the ESG front, we are pleased to learn that MSCI upgraded our rating from BBB to A, a recognition of our strong governance platform and our improving disclosures. One metric we are particularly proud of, and which I mentioned on our last call, is the improvement since 2017 of our safety metrics, which continues year-to-date.
While the safety of our employees is paramount, improvements in total recordable and lost time cases rates provide additional benefits, including enhancing our ability to attract and retain talent and reducing total cost to the business. I also want to again emphasize that the core of our business is inherently environmentally friendly. The installation we install and distribute drives thermal efficiency, lowers energy usage and reduces carbon emissions. We are the leader in delivering these benefits for new and existing homes and commercial and industrial facilities across the United States and Canada. Energy savings we deliver far outweigh the impact of our own operations.
And finally, as you know, Florida was hit by Hurricane Ian in September. While the storm did not have a material impact on our business, several of our branches in the state were shut down for a few days, directly impacting our employees. To ensure their priorities remain with their families during this difficult time, we paid our team in full for the days their respective branches were closed. This is another example of why we believe we are the employer of choice in our industry.
Looking ahead, we recognize there's a lot of uncertainty around the economy. While there is a general consensus the economy is slowing down, the optimists are predicting a shorter calls and growth while the testament see a longer slowdown. Regardless of how this eventually plays out, we believe our business model in both installation and distribution can outperform in any environment. Our team manages the business with a constant mindset of driving improvements and achieving operational excellence. We have the best and most talented operators in the field and a dedicated and experienced group at our branch support center. Our entire team remains focused on continuing to deliver strong results and creating shareholder value in every operating environment. Rob?
Thanks, Robert, and good morning, everyone. We are pleased to report another excellent quarter of profitable growth delivered by our experienced and talented teams across the U.S. and Canada.
As Robert mentioned, both Installation and Specialty Distribution reported strong results with improved sales volume and strong profitability. Our unique business model and relentless focus on driving operational improvements continues to provide us with a significant competitive advantage and positions us to outperform in any environment. We are keenly aware and are closely monitoring the changing economic environment, and our flexible cost structure with over 70% variable cost enables us to make adjustments quickly if conditions warrant.
Moving to the financials. I'll start with an overview of the third quarter results, update you on our balance sheet and provide the latest on our full year guidance.
Third quarter net sales increased 53.8% to $1.3 billion and 22.6% on a same-branch basis. Same branch volume improved both year-over-year and sequentially. Breaking that down, our installation segment's third quarter net sales were $783.1 million, an increase of 27.8%. Higher selling prices contributed 13.8%, increased sales volume added 12.3% and acquisitions accounted for 1.7%.
Specialty Distribution's net sales were $583.5 million, an increase of 111.1%. On a same-branch basis, revenue grew 18.7% driven by a 13% increase in price and a 5.7% increase in volume. Third quarter adjusted gross margin expanded 80 basis points to 30.4%. On a same-branch basis, gross margin expanded 170 basis points to 31.3% driven by operational efficiencies, an increase in sales volume and higher selling prices, partially offset by an increase in the cost of material.
Third quarter adjusted EBITDA increased 63.8% to $259.2 million, and our adjusted EBITDA margin was 19.9%, a 120-basis point improvement compared to last year. On a same-branch basis, our adjusted EBITDA margin was 20.6%, an improvement of 190 basis points from third quarter 2021.
Our third quarter same-branch incremental EBITDA margin was 28.8%, and our acquisition EBITDA margin came in at 17.4% primarily driven by strong results from DI.
Third quarter adjusted EBITDA margin for our Installation segment was 21.6% and 18% for our Specialty Distribution segment, an improvement of 200 basis points and 10 basis points, respectively. Third quarter interest expense increased from $5.5 million to $14.6 million primarily as a result of additional borrowings from our acquisition of DI in the fourth quarter of last year and higher variable interest rates. Third quarter adjustments to net income were $1.3 million and primarily related to acquisition integration costs. Third quarter adjusted earnings per diluted share were $4.80, a 62.7% increase from prior year.
Moving to our balance sheet and cash flows. Our September 30 year-to-date operating cash flow was $335.6 million compared to $309.5 million last year. This was driven by our 67.8% increase in net income, which was partially offset by growth in working capital. Working capital as a percent of trailing 12-month sales was 15.5%, 520 basis points higher than a year ago. This increase was driven by the higher working capital requirements of DI, continued price inflation, ongoing recovery from supply chain disruptions and certain strategic inventory buys related to our industrial business.
Over the long term, our working capital target remains 11% to 13%. On the capital allocation front, September year-to-date CapEx was $56 million, approximately 1.5% of revenue and consistent with our long-term guidance. In addition, year-to-date, we have allocated $20.5 million to acquisitions and just over $200 million to share repurchases.
There were no significant changes to our debt structure, and our outstanding short-term and long-term debt balances remained at just under $1.5 billion. Our debt structure is roughly 60% fixed and 40% variable, with our current average cost of debt at 3.75% and no near-term maturities.
We ended the third quarter with net debt leverage of 1.49x trailing 12 months adjusted EBITDA. This is down from 1.68x at the end of the second quarter and down from our pro forma leverage of 2.2x at the time of the DI acquisition just over a year ago. We are often asked about where we are comfortable taking leverage, and we've noted that between 1x and 2x is a good range for us and is well below our bank covenant of 3.5x. Total liquidity at September 30, 2022, was $591.7 million, including cash of $159.4 million and an accessible revolver of $432.3 million.
Moving to annual guidance. We expect to close out 2022 with a strong fourth quarter. We are projecting total 2022 sales to be between $4.95 billion and $5 billion, a $150 million increase on the low end of the range and a $100 million increase on the high end of the range. We have also raised our 2022 guidance for adjusted EBITDA to be between $915 million and $935 million, a $55 million increase on the low end of the range and a $35 million increase on the high end. Our long-range modeling targets are unchanged from those we published on February 22nd.
I will now turn the call back to Robert for closing remarks.
Thank you, Rob. Before opening up the call for questions, I want to emphasize a few points about our business and the three end markets we serve.
Starting with housing. This end market has clearly been negatively impacted by the Fed's efforts to curb inflation through interest rate increases. As buyers face rising mortgage rates and elevated home prices, many are choosing to stand on the sidelines and take a wait-and-see approach. Despite this following demand, much of the housing industry is still being impacted by inflationary pressures across most of the supply chain, creating an unprecedented market dynamic that will take some time to resolve.
Taking a step back from the current situation, we still believe the long-term fundamentals for the housing industry are solid. The demand may be on the sidelines today, but we believe buyers will return when economic conditions improve, and mortgage rates stabilize.
Our commercial and industrial end markets, which operate on a different cycle than residential housing and contributed 35% of our annual revenue, provide a bright spot in our outlook. Bidding activity is strong, and we have a healthy and expanding backlog. We see continued opportunities for growth. Regardless of the economic environment, TopBuild will continue to focus on driving operational improvements and efficiencies, while adapting our highly variable cost model in anticipation of market changes. We remain confident that our unique business model, combining both installation and specialty distribution, a key differentiator and critical component of our success, should enable us to outperform in any environment. Operator, we are now ready for questions.
[Operator Instructions]
Our first question is from Ken Zener with KeyBanc Capital Markets.
Good morning, everybody. I have two questions, but I guess the first one is, since you mentioned DI was ahead of schedule, I know you broke that into the synergies into different cost buckets. Is part of that related to your purchasing synergies? Because I think that's part of one of your strategic elements is that you really keep strengthening your purchasing power. Could you expand on that, please?
Yes, Ken, this is Rob. So from a DI perspective, definitely another strong quarter from them. We couldn't be more pleased with their performance. Since the acquisition, their volume, really strong again in the third quarter, similar to the second quarter. We want to keep reminding folks, the volumes there can be a little bit choppy due to the project nature of the business. And then, obviously, you're seeing our M&A EBITDA really strong, ahead of our guided range, and DI obviously makes up over 90% of that.
And a lot of that is driven by the volume that we're driving, but also then the synergies that we're realizing. So if you go back to what we signed up for, the $35 million to $40 million run rate, we said we'd be about halfway there through the -- by about this time. And we're a little bit ahead of that right now. So from a supply chain perspective, we basically realized all of those synergies. From a back-office perspective, I'd say we're a little over half of the way there on those. We just completed the ERP conversion, which is going to help us drive the rest of those efficiencies.
And then on the operations side, we continue to search for things on that side. We're probably a little less than halfway there on that piece, but we have driven synergies from insurances, logistics and indirect spending. So as you can see in the numbers, we're really happy with the performance there.
Yes. No, that's good. And then, Robert, you mentioned, not to paraphrase you, but the builders are beginning to push back on price. Given at least the public homebuilders, we can see that their starts are down about 25% year-over-year. Obviously, that's a little cleaner than the census data, and you guys have probably the best data in the country. What does that mean pushing back on price? I mean, with you announcing price increases from the manufacturer, that would seem to point to margin squeeze. It's been a very good run-in recent year. So I'm looking at the fourth quarter '18 when you guys actually had -- I think you only down margins modestly, but your margins were at 12%, not where they are today when you had negative volumes. So could you just try to give comfort around how that 70% operating leverage you see unfolding next year when starts are clearly going to be down? Thank you so much.
Sure. So I'll take the first part of that, Ken, relative to the builders. So obviously, a lot of conversations. If you take the past two years, given what was happening with the demand curve, there was a lot of conversations then. But as you saw the inflation, and people were concerned about labor and stuff as well, those conversations exist in the past two years, but there was a lot of demand drivers there as well. As things have started to show the signs of slowing, it's just further conversations. But I would say the backlog is still there. I would also say that labor is still at a premium. Fiberglass is still on allocation.
So but there are lengthier conversations, more conversations, if you will, with the builders. They still recognize them, the supply chain constraints. But they obviously see what's on the horizon here. So it is a dynamic here. There's inflation. They see the slowdown. So it's further conversations, and partnerships with each one of those builder customers really across the country, and that's really the big builders, but also the regionals and the smaller builders as well.
Yes, Ken, and I'll just add to that, I mean, as far as from a margin perspective and looking forward, right, I think the best word to use, where we sit today is we're cautious, right? I mean, it's unprecedented times, as Robert's talked about. And so we're cautious where things are going to get sorted out here on the residential side. And you see that in our guidance, right? Our EBITDA margin for the fourth quarter is coming down a little bit from what we had here in Q3.
Our next question is from Stephen Kim with Evercore ISI.
Yes, thanks very much guys. Appreciate all the information. I guess, my first question would be related to the residential side of the business. There's been a pretty big difference between trends in multifamily and single-family recently. And I was curious if you could talk a little bit more about what you're seeing in multifamily residential, specifically high-rise, mid-rise versus low rise. Perhaps, you could give us a sense for what your market share looks like within the multifamily space. And are you seeing significantly different trends in multifamily versus single-family so far? Maybe give us a little sense for what the competitive dynamics look like in multifamily versus single-family. Thanks.
Yes, Stephen, this is Robert. So you're right. I mean, if you look at our performance in Q3 and as we started off Q4 strong here, definitely as trade ahead of us have shown some improvement. Especially with the single-family side, you never see that into the backlog that we're working. But the multifamily bidding is very strong. I'd say the backlog in multifamily had a historical high level. So no doubt about it. I think even if you look at the census data of units under construction, that percentage of multifamily has continued to grow if you look back over 2022 here.
So a lot of multifamily work out there for the future, really, I'd say across our markets, if you -- if I look -- if I had looked at it maybe earlier this year and today, some markets on the multifamily side seem to be a little saturated. But we're seeing bidding activity and potential projects pretty strong across the board in multifamily. I think given some of the dynamics that exist, and you see some of that multiuse type of multifamily where you'll see units up top, some retail down to the bottom, we still see that as some of the trends as well.
And how about your market share? Like how does that look in terms of your ability to service in that side of the business?
Yes, good question. I missed that. So we're pretty well aligned with the starts. If you look at how we're kind of orientated more on the market share side with multi-families, we're pretty aligned with that same start percentage as well.
Okay. That's great. That's helpful. And then I think just another clarifying question here. When you talk about commercial, are you including multifamily in that? I know sometimes some folks do. And then last time you talked about labor shortages, it may be extending cycle times and maybe depressing a little bit of activity in commercial. Has that situation improved at all?
Yes. So on the commercial side, we do not include multifamily and commercial. So anything that census reports as units, we included on the residential side. So multifamily is not included in those commercial numbers or in our outlook for commercial. And then relative to -- what was your second question there?
Just like labor shortages.
Yes. So we talked about that last time relative to labor on the commercial. So I wouldn't say that's improved. I'd say as the backlog has continued to get work on the residential side, that labor is really not -- none of that shift to commercial. So we still see a cycle time extension on commercial projects, both light and heavy commercial both.
Our next question is from Adam Baumgarten with Zelman & Associates.
Hey, good morning, everyone. Just could you give us a sense maybe the magnitude of improvement you potentially saw in homebuilder cycle times if we look at the third quarter versus the first half? And just given the still elevated backlogs, when would you expect some of the recent starts weakness to start to show up in your results?
Yes. I'll take the first part on the cycle time. Rob can help on start discussion. So cycle time, we definitely say the trades in front of us improved, thus the reason we been into that backlog, especially on the single-family side here in Q3, probably even going back earlier in the year Q2, we were probably into that backlog as well. And we would say, look in at the start of the fourth quarter. So I'd say that's improved. Hard to say, but actually maybe a couple of weeks on the front-end piece of it, if you will. I think if you listen to the builders, the back-end trades really haven't caught up. And even some of the public builders have said that got a tad bit worse in the quarter.
So I don't know that overall cycle times have improved, but we would say definitely trades in front of us, we've seen some improvement for sure. And I think the builders stated pretty much, so very similar to what we saw on cycle times.
Yes, Adam, this is Rob. I would just add to that. I mean, if you look at our volumes in the quarter and even year-to-date, I mean, we're significantly outpacing completions right now. So that's kind of the evidence we're looking at to say that, hey, we're working into that backlog a little bit here. So our best estimate, we definitely think the backlog is going to last us into Q1, but then obviously, a lot to get sorted out after that.
Okay. That's helpful. And then just on the upcoming fiberglass price increases from the manufacturers, a couple of questions. One, do you think they'll largely stick given tight capacity? And as we look out to next year and maybe some of the conversations you've had, do you expect a return to a more normal cadence maybe a couple of a year in '23?
Yes. Let me take the second question first. This is Robert. So hard to say. I think it depends on that demand curve through '23, what that cadence of increases looks like for '23. So that was one a little harder to say. I think it again to on that demand curve piece, and that obviously drives how much supply is available. Relative to the current increase, I mean, fiberglass still is on allocation. Labor is still tight, but we're going to have that dynamic that I think Rob and I both spoke to where some president of piece of builders are definitely having more conversations and pushing back on that, but there's still inflation really across the industry right now.
So those are going to be more in-depth conversations for sure. But there are some dynamics there working where material is still on allocation. So it will be a very balanced conversation. And as we've said here, we're kind of cautious about that outlook as we go into those conversations December and January, and that increase starts taking effect.
Our next question is from Mike Rehaut with JPMorgan.
Hi, guys. Good morning. Doug Wardlaw on for Mike. I just wanted to know how we should think about decremental margins, amid a 10% revenue decline.
Yes, Doug, so this is Rob. So our goal on a decremental is to be similar to our incrementals, so somewhere in that 22% to 27% range. But it will vary. And a couple of things that will make that vary, one is that 10% decline depending on how long we think that's going to last, we may hold on to labor a little bit longer. So that will obviously -- that could make that decremental a little bit worse. And then the other thing that could make it a little bit worse is on the price side, right? If that 10% decline is volume based, for sure, we expect that decremental to be closer to that 27% number. But if it's price related, we still got to go do the work, so we don't variabilize the direct labor piece of that as much. So that would make that flow through a little bit higher on that case.
Okay. Great. And then how much visibility do you guys have in both your industrial and residential businesses? And how do you see those end markets moving forward in this environment moving into '23?
Yes, I think as far as visibility, so if you think about commercial and industrial, pretty good visibility. I mean, we're bidding projects well into '24 now in the commercial space and in the industrial space. And I think about some of that, especially on the mechanical insulation side, some of that was slower to recover coming out of the first round of COVID, if you will, so that really started recovering, call it, later in '21 or mid-'21.
So I'd say based on projects, we see based on projects that we're bidding, based on projects that are getting started, as we said, we think that's a bright spot here. And again, a key part of our model about how we differentiated TopBuild with that commercial and industrial business now being 35% of the revenue. So and there's some really good capital spend projects coming up across both that commercial and industrial space.
Doug, and this is Rob. I would just add to that. We look at a lot of the leading indicators that others look at as well, ABI and the Dodge Momentum Index. And definitely, those are pointing towards growth. So we're cautiously optimistic in that area for sure. Obviously, knowing that interest rates, if they continue to rise, could have an impact on that space as well. But like we said, we think there's reason for optimism on that front.
Our next question is from Phil Ng with Jefferies.
Hey, guys. This is Maggie on for Phil. I guess, yes, I guess my first question is around pricing. Maybe looking past this December increase into 2023 with a weaker demand backdrop and potentially declining installation pricing, how do you see yourself kind of managing that spread? Particularly with your labor piece, just how do you see your pricing playing out in a weaker demand backdrop?
Yes. So this is Robert. So if you think about that, and I'll just focus more on the labor side of the equation here. So even if you back to our housing starts were $1.3 million, $1.4 million, labor was still a constraint. And so I think you're still going to have that value-add piece of what's going on in the labor side of the equation. We say that there's enough fiberglass to really for 1.5 million housing starts. That's running at full capacity. There's going to be maintenance issue in the industry as well. So I think that will play in the discussions. I think it will depend on that demand curve and where does it go. But again, I think labor will continue to be at a premium. And obviously, we provide great service. We have great relationships across the footprint. So little bit of the unknown there, but I think there are some knowns relative to labor capacity in the industry.
Okay. Got it. That's helpful. And then it looks like you closed some small acquisitions this quarter. Can you just talk about what you're seeing in the M&A market with multiples or the types of deals out there? And how does your approach to M&A change going into a potentially more challenging demand backdrop?
Yes, Maggie, this is Rob. So from an M&A perspective, obviously, we've done a little less on that front this year. Our focus is really on the DI integration, which has gone great. And we're really getting focused now, getting us getting the pipeline filled up on the M&A front. We know, even if there is a downturn, we're going to continue to generate cash, and we're hoping to pick up some deals in that time frame. I mean, obviously, from a financial perspective, we got to be disciplined on that front. Knowing that there's uncertain times ahead, we're modeling things in various scenarios, looking at downside scenarios, so making sure we don't overpay for any assets. But it's certainly going to be a big part of our strategy going forward.
Our next question is from Jeff Stevenson with Loop Capital.
Hi. Thanks for taking my questions. And congrats on the nice quarter. I just wanted to dive into the strong volume improvement on the quarter. Was this primarily driven still by the catch-up in elevated completions? Or were there share gains there as well?
Yes. I mean, Jeff, this is Rob. I mean, from our perspective, our best estimate is that, I mean, there could be some share gains in there, but our best estimate is that we're working through that backlog that's out there. So there's a historic level of how units under construction right now. And as we've exceeded that completions number for several quarters in a row, we're pretty certain we're eating into that backlog.
And this is -- Jeff, this is Robert. So just to build on what Rob said, I mean, nice commercial volume in the quarter. We were right to see improvements there, and we think that's some good signs of what's going on there commercial and industrial, quite honestly, both probably service partners side, we'd say it was an easier comp, if we compare it to Q3 of '21 as well. But the teams in the field did a great job really servicing the customers whenever we have the ability to work that backlog and stuff. So we're really happy with the volume and what happened in the quarter.
Great. That's helpful. And then you had a strategic inventory buys last quarter, particularly with DI. And I'm just wondering, is that largely done now? And then current inventory levels, just wondering kind of where they're at right now? And do you see any need for potential destocking in the future?
Yes. So this is Rob, Jeff. So from an inventory perspective, we do still have some of the strategic buys on hand. It's roughly about $20 million of inventory. In addition, we're a little heavier in certain areas where we've had some supply chain disruptions and lead times change, and then you get a bunch of inventory in. So that's probably another $20 million in certain categories. So there's definitely some opportunities for us to lean that down, and it's definitely a focus of ours. If you look at the prior year, we're about five days of inventory every year on an apples-to-apples basis with last year.
Our next question is from Trey Grooms with Stephens.
Hey, good morning. Thanks for taking the question. Rob, you guys have a highly variable cost structure. It's fairly capital light as well. And sorry if I missed this, but how should free cash flow behave once we see the lower starts begin to move through the system and start to possibly negatively impact demand for you guys, I guess, maybe after first quarter of next year, I think is what you pointed to? I'm sure working capital should be a strong source of cash in that environment. But any color on maybe how conversion rates may change? Or any additional detail on free cash flow generation in a down market?
Yes. Trey, you hit on it for sure. I mean, with our high variable cost structure and our capital light, with 1.5% of our sales roughly going towards CapEx, we'll continue to generate strong cash flow, even if we do have some downward pressure on sales. And we'll have working capital come out of the system in that first year, right? So we'll get a onetime benefit as AR gets collected. This year, we kind of got the onetime hit with organic sales growing over 20% for the year. We've obviously increased AR and inventory to support that. That's really been the biggest piece of our working capital increase.
So in a downtime, if that's what you're forecasting for next year, we will get the benefit of that coming back. So the first year of a downturn, there's definitely a free cash flow benefit.
And kind of a follow-up to a question earlier, you talked about still having appetite for M&A kind of through the cycle. But in the absence of good M&A targets out there, that just don't work out for whatever reason in the absence of M&A, with this free cash flow, what are your next kind of priorities as you kind of look at the capital allocation?
Yes. So Trey, we're always focused on making sure we keep a conservative balance sheet. Right now, we're working in a cyclical industry here, so we're going to stay focused on that. And obviously, if things get worse, we'll be more conservative on that front, hold cash a little bit longer. But if this turns out to be an air pocket, we're certainly going to be -- like we said, we're going to be aggressive on the M&A front. But knowing that, that can be choppy and the timing of that varies, just like we always do, we'll continue to evaluate options of returning that cash to shareholders, which, thus far, we found buybacks to be the most efficient with that. So I wouldn't be surprised to see us continuing with that moving forward.
Our next question is from Reuben Garner with Benchmark Company.
Thank you. Good morning, everybody. So the new housing piece, I understand, I wanted to see or get your thoughts on the potential positive impact of the Inflation Reduction Act and the tax credits on the repair and remodel side. I know it's not historically been a huge part of your business, but are there any opportunities for you guys to maybe participate there in a bigger way, particularly in light of the softness in the new housing side that's likely to come next year?
Reuben, this is Robert. So there are definitely some opportunities there as people who look at the credits that can happen coming from multiple different directions. There's a possibility of some maybe re-insulation, if you will. I'd say the bigger upside is through some of our testing programs because there's going to be some credits going back, including, I think, to the builders relative to ratings of homes and stuff. So as you know, we're the largest rater in the U.S. with our TopBuild Home Services business, there's probably more upside from that perspective and the value add that we bring on that side with that act that you mentioned.
Okay. And then on the commercial and industrial front, I guess a two-part question. One, are you seeing any signs of softness kind of early pipeline to date? And then can you remind us how the backlog looks and works there relative to housing? Obviously, the prolonged construction cycle in residential gives you some visibility at least into the early part of next year. Is there a similar dynamic in the C&I side?
Yes. So definitely, the commercial and industrial works on a different cycle than residential. And then if you just kind of break it down a little bit further, if I think about the building envelope and like commercial, that's going to follow some residential trends but on a different cycle, right, because as you're building infrastructure in a community to support the new communities that like commercial follow that. Heavy commercial there's such a backlog and those projects have been delayed, and the cycle time of those projects have extended. It's just continued to build that backlog. So I think that cycle has even been more extended on the heavy commercial side.
Then if I think about mechanical insulation, there's been some different dynamics there. One is that was later to start the recovery. Number two is there hasn't been the -- as many of the supply chain constraints on that piece of the business. And so there's a lot of good capital spend going on there. Some of that could be infrastructure related. But there's also projects that are required to kind of move forward given regulatory environments, that type of thing. That's why thinking about that business and then think about that MRO, that maintenance repair side of the business, that's a real positive on that.
So whenever we look at projects, projects we're bidding, projects are coming online and even projects we're talking to customers about, we think there's definitely some good positive momentum. Commercial and industrial again, both on the mechanical side and what I'll call the building envelope side as well. And then the third piece of that is, as you know, we're the largest player in the metal building space. There's been some really positive trends there, and we expect that to continue to show positive trends here as we go into '23.
Our next question is from Keith Hughes with Truist Securities.
Thank you. In the future, if you do get pressure from the builders on installed insulation pricing, how quickly can you get some relief from the manufacturers? Would there be a drag associated with that? Or do you have other mechanisms in place that would make it faster?
Yes, I think that Keith, this is Robert. I think that's the dynamic that you hear Rob and I talk about, right? I mean, in the past, you know how this works, right? Volumes start to slow. We work with the manufacturers on the input cost. But while the inflation still exists, there's pressures on both sides there. So this is going to be a little different dynamic than folks have seen, and that we'll have to -- as I think we said in the prepared remarks, we will take a little time for this to evolve and to play out here.
So that being said, I think you've seen from us, we're great at executing across our footprint, across the branches, given some of the tools that we have and given the great leadership that we have in the field. So we'll continue to strike that appropriate balance, but it is a very different dynamic today than it has been in the past. And you've been around this industry for a while, so I'm sure you can recognize that as well.
Right. Just one other question on spray foam. If you talk about availability there, I know there's been a lot of ups and downs in chemical, but prices and supply, where you stand?
Yes, definitely improvement. I think probably last call, we talked about the open sale had improved. Even in the closed sale, although tighter than the open sale, we see some improvement on the post-sale side of the materials. Taxes improved. That being said, costs are still elevated there. And no question that we usually get about that relation to fiberglass, we still say that comparisons escalated us to the spray foam is probably in that ballpark of still 3x the amount of fiberglass. But definitely, the supply chain there has improved.
Our next question is from Dan Oppenheim with Credit Suisse.
Great. Thanks very much. Just a quick question in terms of the acquisition environment. Given what you talked about in terms of the potential margin pressure from sort of increasing costs into the pushback, what does that make you think in terms of some of the other smaller competitors seeing, same thing looking for some liquidity in this environment? Does that make you any more optimistic in terms of the ability to look for acquisitions, understanding that you're still looking at scenarios and being cautious as you proceed with them?
Yes. Dan, this is Robert. Rob and I will tag team. I would say in the environment, it's a little bit of a mixed bag. You've got some folks, some of the smaller contractors, if you will, that are thinking about now it could be a time to make that decision. You got some that are still performing well, and they think they got some more runway left in the business there to drive improvement. So a little bit of a mixed bag.
Yes. And I'd just say, Dan, it's where our -- the modeling we do on these deals is critical, right? And we're being, like I mentioned earlier, even more cautious now in terms of modeling downside scenarios and making sure that we're not overpaying. So we're looking at those dynamics and those risks that are out there and valuing those in the deals as we look at them.
We have reached the end of our question-and-answer session. I would like to turn the conference back over to management for closing comments.
Thank you again for joining us today. We look forward to reporting our fourth quarter results in February.
This does conclude today's conference. You may disconnect your lines at this time. And thank you for your participation.