Specialty Products and Insulation LLC (BLD) Earnings Call Transcript & Summary

Greetings, and welcome to the TopBuild Conference Call and Webcast. [Operator Instruction]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tabitha Zane. Thank you, Tabitha. You may begin.

Good afternoon. On the call today are Robert Buck, President and Chief Executive Officer; and Rob Kuhns, Chief Financial Officer. We have posted a PowerPoint presentation on our website at www.topbuild.com that will be discussed in conjunction with management's prepared remarks. Turning to our safe harbor statement. 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 afternoon'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. I'll now, turn the presentation over to Robert Buck.

Good afternoon, and thank you for joining us on such short notice. It's an exciting day for TopBuild and our stakeholders. A short time ago, we announced that TopBuild has entered into a definitive agreement to acquire Specialty Products & Insulation or SPI as we'll refer to the company on today's call in an all-cash transaction valued at $960 million. This acquisition brings together 2 leading specialty distributors have mechanical insulation and further differentiates TopBuild's unique operating model. We are excited about this transaction because it adds scale and capacity to better serve our customers and further reduces the cyclicality of our business by increasing our recurring revenue stream. Equally as important, we expect it will drive significant returns for our shareholders as we look to achieve $35 million to $40 million of run rate cost synergies within 2 years after close. SPI supports our profitable growth strategy, expanding our North American footprint and broadening our exposure to all 3 insulation end markets: residential, commercial building and commercial and industrial mechanical. We see great opportunities to drive mutual operational improvements throughout the business and are particularly excited about SPI's high percentage of recurring revenue from maintenance and repair operations, especially on the industrial side. The SPI leadership team is talented, experienced and engaged and they're excited about bringing their expertise to TopBuild. Having spent time with Ray Sears, President and Chief Executive Officer of SPI, as well as other members of SPI's leadership team, it is clear that our corporate values and culture are very similar with a strong emphasis on people, safety, integrity and execution. TopBuild has built a strong foundation for growth, which has prepared us for this next phase of expansion in our core insulation business. Throughout our history as a public company, driving operational excellence and executing well on our strategic goals have been our most important areas of focus. This has resulted in strong financial results for our shareholders. Through a combination of organic growth and acquisitions, our 5-year compounded annual growth rate for revenue is 21% and 37% for free cash flow, plus our adjusted EBITDA margin has expanded by 840 basis points and our total shareholder return is 244%. We are confident TopBuild's business will be further strengthened for the future with the addition of SPI. Our acquisition strategy is disciplined and strategic and our ability to successfully integrate the companies, we acquire ensures we deliver strong returns for our shareholders. Our acquisition criteria is simple but important. We look for leading companies operating in our core business of insulation. They must be strategic in their business approach and provide value accretive growth opportunities. They must have strong relationships and a solid reputation with our customers as well as an engaged and talented team that leads a culture complementary to ours. Given this criteria, SPI is a great fit with TopBuild. However, while identifying acquisition opportunities is essential, the ability to successfully integrate these companies onto our systems and platforms is even more critical. I'm proud to say this is a TopBuild core competency and one of the keys to our success. Two great examples, our highly successful integration of BI acquired in October 2021, and our return on invested capital, which has increased from 8.6% in 2017 to 18.5% at the end of 2022. I'd like to take a step back for a moment and talk about the evolution of our Specialty Distribution segment over the past 6-plus years. In 2017, it accounted for 33% of our total revenue and primarily distributed insulation products and accessories to the residential end market within the U.S. Over the next few years, we made some important changes, bringing in new and energized talent into the business, walking away from unprofitable volume and driving operational service improvements throughout our branch network. When the opportunity to acquire DI rose in 2021, we were thrilled to expand into the third insulation end market, commercial and industrial mechanical insulation. This core installation area had been on our strategic road map for a number of years, and it was our time to execute. For those who know the TopBuild story, the DI acquisition has been a home run for our company and stakeholders, providing us a leadership position in this highly fragmented end market. Fast forward to 2022, and our Specialty Distribution segment now has a strategic fabrication footprint, operates in both the U.S. and Canada and is the leading provider of insulation and related accessories in all 3 insulation end markets we serve, which combined represent a total addressable market of $17.5 billion, excluding the non-insulation products we sell. With the acquisition of SPI has completed, our Specialty Distribution segment will expand once again. 89 branches will be added to our network and recurring revenue for the segment were increased to 1/3. In total, Specialty Distribution will contribute approximately 46% of TopBuild's total revenue. I'll now turn the call over to Rob, who will talk about the transaction in further detail.

Thanks. As Robert mentioned earlier, we have agreed to acquire SPI in an all-cash transaction valued at $960 million on a cash-free, debt-free basis. Using the purchase price of $960 million, less $90 million of tax benefits, the transaction last 12 months multiple on a pre-synergy basis is 11.4x and 7.6x post synergies. We intend to fund this transaction with cash on hand and a $550 million delayed draw term loan. Once the transaction is completed, our net debt to pro forma adjusted EBITDA as of March 31, 2023, will be approximately 2.0x within our previously stated comfort zone. We expect to delever quickly, as we have in the past after similar transactions. The transaction, which has been approved by our Board of Directors is subject to customary closing conditions, including expiration or termination of the waiting period during the regulatory antitrust review. We give you a little bit more background on SPI. The company has been in business since 1982 and is headquartered in Charlotte. They are currently owned by Incline Equity Partners. SPI has strong and long-standing relationships with major insulation manufacturers and is national in scope with 89 locations, 85 in the U.S. and 4 in Canada. SPI has been acquisitive and brings with it strong business -- a strong business development team and a robust pipeline of acquisition candidates. Breaking down SPI's revenue mix. 64% is generated from the distribution of mechanical insulation products, 21% from building insulation products, primarily spray foam, and an additional 15% from metal building insulation products. 81% of their products are sold into the commercial and industrial end markets and 19% into the residential end market. SPI also enjoys strong recurring revenue stream, which is primarily driven by maintenance and repair work. This next slide shows the 3 core insulation markets that both TopBuild and SPI serve, which combined represent a total addressable market of $17.5 billion, excluding the non-insulation products we sell. SPI sells into all three of these end markets. These products include mechanical insulation, metal building insulation, fiberglass and spray foam. SPI custom fabricated mechanical installation for commercial and industrial facilities and provides customized solutions for a wide variety of commercial building projects. Slide 11 shows what TopBuild will look like with the addition of SPI to our company. As Robert noted earlier, Specialty Distribution will account for 46% of our total annual revenue compared to 39% today. Our focus remains on core insulation products, which will increase from 84% to 86% of our total revenue. Revenue from the commercial and industrial end markets will account for 39% of our total revenue compared to 34% today. In addition, Specialty Distribution's recurring revenue stream will be roughly 1/3 of this segment's total revenue. As outlined in today's press release, we expect to achieve synergies between $35 million and $40 million within 24 months after the close of this transaction. Breaking this out further. By the end of the first full year, we expect run rate cost savings to be between $17 million and $20 million. The synergies will be from a combination of supply chain savings and operational improvements as well as leveraging technology and best practices across the entire organization. Finally, before turning the call back over to Robert, I want to reiterate how strongly we believe this transaction provides significant value for our shareholders and is a great use of capital. We're acquiring a well-run company that is complementary to TopBuild business. And as you've seen from our Specialty Distribution solid results, we are effective at leveraging our core capabilities to deliver strong returns on invested capital. Robert?

Thank you, Rob. The acquisition of SPI is another important step for TopBuild, bringing together two leading specialty distributors to further promote innovation and deliver best-in-class customer experiences. This transaction will reinforce our leadership position in a large and highly fragmented insulation end markets. Plus, additional scale and capacity SPI brings will enable us to better serve our customers and partner with our suppliers throughout North America. SPI also enhances our position as a leader in supply and energy saving insulation solutions. Insulation is critical for the reduction of a company's carbon footprint, and we believe energy codes will continue to strengthen, providing additional growth opportunities for all areas of TopBuild's business. There are already in integration planning stages, so that when the deal closes, we can hit the ground running. I assure you the leadership teams at both companies are committed to helping ensure a smooth transition, and we are confident we can achieve the synergies we published within the time frame outlined, and drive overall value creation for the business. We will leverage our track record of strong execution to make this combination a great success. We see this acquisition as a winning combination that will drive value for our stakeholders and our successful track record supports this confidence. Operator, we are now ready to take questions.

Thank you. [Operator Instruction]. Our first question comes from Joe Ahlersmeyer with Deutsche Bank.

Congrats on this acquisition. Looking forward to seeing what you guys can do with it.

Thank you...

Just looking at the release, I see the word install, and I see a lot of the end markets that you've set install maybe doesn't make a lot of sense for you. Just maybe wondering if the install is ring-fenced to the residential side of what you're acquiring here.

This is Robert. Rob and I have a tag team. So yes, there's really nothing on the install side of the business with this transaction. It's all distribution. But one thing we like is that SPI does play in all 3 of the end markets. So they are in the residential space, but they're distributing spray foam and spray foam equipment. That may be what you're seeing. But this is all distribution, Specialty Distribution, no installation as part of this.

Okay. Great. Just had to follow up on that. And then, thinking about what this adds as well, if we're looking at maybe the footprint, is there anything to call out there? I think you said they're nationally scaled, but even just looking regionally, are there pockets where you're getting into that you're not currently? And then, on the fabrication side, if you could just talk maybe more specifically about what the additional capabilities are that you're acquiring here?

Yes. Great question, Joe. So on the footprint, that's one thing we really like about the transaction. It gets us in some bite space areas, where we're not present today, a stronger footprint in the Southeast than I would call out specifically Florida, where today, our distribution international footprint from a mechanical perspective is not in Florida. This gets us into a great market in Florida, a stronger footprint in the Southeast. And I also would point out the Northeast, which as you can imagine, with these mechanical type of products, how big that Northeast area is from a service perspective. So, it's going to give us a nice complementary footprint we get us into some nice white space areas. And I would say the same on fabrication, definitely SPI and DI are both very strong core competency and fabrication of those engineered mechanical insulation parts. So it's going to complement that, both in the U.S. and Canada. So it's going to really give us some great opportunities to serve our customers in really a unique fashion that everybody has the capability to do other than us.

Our next question comes from Rafe Jadrosich with Bank of America.

Just on the recurring revenue. Can you just give a little bit more color there in terms of the visibility that you have on the backlog, do you have like long-term customer contracts on the SPI side to sort of prevent churn? And then, what is sort of the breakout of new construction versus R&R in that recurring revenue? Is this more of an R&R leverage business?

Yes. So let me start with the -- from a recurring revenue perspective. So this is the things you would think about kind of required and nondiscretionary kind of maintenance types of insulation installation accessories or mechanical systems. And so yes, there's definitely contracts with it could be oil refinery type customers or clients you think about, they have to do regular turnarounds in those facilities. It can also be areas like food and beverage industry, where there's regulatory requirements for the replacement of certain types of equipment, where you think about high temperature or also some environmental conditions where these pipes in this example may be exposed to. So yes, definitely long-term contracts, definitely, what we call maintenance and repair work, heavy in the industrial and the commercial side. And if you think about that SPI revenue piece of it, and Rob may want to add something here as well. But kind of new construction is about 50%. This repair and maintenance or as you referred to, maybe remodel, that's 50% of it as well. So it's kind of a 50-50 split there in that SPI revenue that we spoke to. So we love that recurring piece. It really brings our total Specialty Distribution segment to about a 1/3 revenue split of that recurring revenue at the -- on the other side of this transaction.

Just following up on that. For what -- how far out is your visibility in terms of the revenue there? Is it similar to your existing nonres business where you're already seeing bidding out into 2025? Just trying to get a sense of the backlog that's already there.

Yes. So if you think about some of the large, what I'll call, turnarounds, which is what the refineries do, those are pretty well planned projects. So yes, you do see visibility of that, definitely out into what I'll call 12 to 18 months out as they're planning that and they bring us into that fold as we're looking at the plans and giving them options as to what they can do there. So there is some visibility, especially the bigger projects, which as we talk about in this space, there comes with some bigger projects, as the time frame goes through the project cycle.

And then last one is just can you just talk about the post-deal market share for the key end markets?

Yes. Rafe, this is Rob. So from a high level, like we said, the nice thing about SPI is they're selling into all the same end markets we sell into today, right? So it's highly fragmented in all of those, like we've talked about, it's a $6 billion residential market, $6 billion commercial building market. $5.5 billion commercial and industrial mechanical market. We'll pick up a little bit of share on the residential side. That's obviously the smallest piece of what they do today. It's about 19% of their revenue is going into the residential space. The other $81 million is going into commercial and industrial. In the commercial building with our MDI business will still be around that low teens type market share. So we were talking about 11% before. We'll pick up a couple of points there. And then, on the commercial industrial mechanical, we're also -- we're about 10% today. That's obviously the biggest piece of their business. Today, it's about 64% of their revenue. So it will be somewhere mid-teens type share in that side of the business.

Thank you.

Our next question comes from Stephen Kim with Evercore.