Earnings Call Transcript - LMB Q4 2022

Operator, Operator

Greetings, and welcome to Limbach Holdings Fourth Quarter and Full Year 2022 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jeremy Hellman of the Equity Group. Please proceed.

Jeremy Hellman, Host

Thank you very much, and good morning, everyone. Yesterday, Limbach Holdings announced its fourth quarter and fiscal year 2022 results and filed its Form 10-K for the year ended December 31, 2022. The company would also like to note that an updated investor presentation is available on the Investor Section of the company website at www.limbachinc.com. Management will refer to select slides during today's call and encourages investors to review the presentation in its entirety. During this call, the company will be reviewing those results and providing an update on current market conditions. Today's discussion may contain forward-looking statements, and actual results may differ from any forecasts, projections or similar statements made during the earnings call. Listeners are reminded to review the company's annual report on Form 10-K and quarterly reports on Form 10-Q for risk factors that may cause the actual results to differ from forward-looking statements made during the earnings call. Also, please note that during the question-and-answer session at the end of the call, we will only be taking questions from our analysts. With that, I'll turn the call over to Charlie Bacon, the President and Chief Executive Officer of Limbach Holdings. Please go ahead, Charlie.

Charlie Bacon, CEO

Good morning, everyone, and welcome, and thanks for joining us. Joining me this morning is Mike McCann, our COO and Incoming-CEO; and Jayme Brooks, our Chief Financial Officer. We've reported another solid quarter and exceeded the upper end of our adjusted EBITDA guidance for the year. For the past several years, we have met or exceeded our adjusted EBITDA guidance, and I credit that to the risk management practices we installed in the business as well as our game-changing strategy of rapidly expanding our owner-direct revenue segment, as we call it, and focusing on the quality of the General Contractor backlog. The financial results produced from our rapid owner-direct revenue growth, coupled with our earnings from better project selection, have led to a steadily improving cash position, all of which helps to demonstrate that our strategy is working. One significant event during Q4 that I would like to comment on is we successfully resolved one of our significant claims and expect to collect approximately $10 million in cash. There are two legacy matters that remain, exceeding $30 million, and we are patiently yet aggressively working those opportunities to maximize our outcomes. As you know, this will be my last earnings call leading the conversation. After 19 years as CEO of Limbach, I'm trying to take on some other challenges and opportunities that life offers. Mike will be stepping up to the CEO role on March 29. The work he and I have done over the past three years preparing for this with the full support of the Board is one of the highlights of my career. I believe we have executed the CEO selection well. In addition to the succession planning work, Mike and I have been working together to build out a senior leadership team with the full support of the Board. We have built a very strong and capable team of leaders. We strongly believe that the strategy we have deployed has Limbach well positioned for its next chapter, which will be one of value creation, expansion, and cash generation. I'm extremely happy to be handing the leadership of the company off to Mike and look forward to transitioning from my role as CEO to that of a shareholder with a sizable position. I greatly care about the company and all the employees and look forward to watching this next chapter of the company under Mike's leadership. Let me now turn the call over to Mike and Jayme to share the results of the quarter and the full year, as well as the outlook for 2023.

Michael McCann, COO and Incoming CEO

Thank you, Charlie. It's been a pleasure working with you, especially over the last few years as we've set our owner-direct revenue transformation in motion. I also want to thank the Board of Directors for their support and for appointing me as CEO. I'm excited about our plans for Limbach and note that our new investor presentation has some expanded discussions about our vision. Turning to our results, I want to provide some high-level comments on our performance in 2022. Jayme will follow with some further financial highlights, and then I'll return to discuss what lies ahead before we open up to questions from our analysts. As Charlie noted, we closed the year with a strong fourth quarter that resulted in adjusted EBITDA exceeding guidance for the year. That marks the third consecutive year of meeting or exceeding our guidance for this line item, which we attribute to our emphasis on bottom line performance. We continue to focus on growing our owner-direct revenue segment while aggressively pushing margins as a primary project selection criterion in our General Contractor business. Within the General Contractor business, the emphasis on margins continues to result in an expected modest top line contraction. As results demonstrate, our rigorous project selection criteria have gone hand-in-hand with quality execution in the field, driving improved gross margins in the segment. Given this success, along with the composition of our backlog, we have updated our target General Contractor gross margin range from 12% to 13% to 12% to 15%, which is summarized on Page 7 of our investor deck. Our consolidated yearly revenue came in just shy of our guidance range, primarily driven by supply chain-related equipment delivery delays, which pushed some revenue from late in the fourth quarter into 2023. We don't believe those delays indicate any deterioration of the supply chain conditions and remain focused on providing our customers additional visibility and guidance in this area, both in terms of longer-range capital equipment planning and the need to be highly proactive in maintaining existing equipment. As we have noted on our last couple of calls, this paradigm has resulted in strong demand for our service and maintenance capabilities. Our customers often have facilities where they simply cannot afford to close due to broken mechanical systems. As shown on Page 5 of the investor deck, the key end market attributes we seek are favorable demographic support, good secular trends, and most importantly, a mission-critical facilities infrastructure. This is driving plenty of work for us, especially time and material work as we keep those systems operational. Over the mid to long-term, we believe this continued deferment of capital equipment replacement also represents pent-up demand for Limbach. As equipment becomes available, we anticipate working with our customers to provide those equipment change-outs. Among the verticals we consider our primary markets, the positive attributes we look for are supporting strong demand in healthcare, data centers, and R&D facilities, to cite a few. In some cases, infrastructure development in adjacent markets does not directly impact us, but it contributes positively to an overall favorable demand curve for our skilled labor, allowing us to see improved margins. I'll now pass it off to Jayme to provide some financial highlights, after which I'll return to address the macro outlook in our guidance for 2023, along with some comments regarding my vision for the company before we take questions.

Jayme Brooks, CFO

Thanks, Mike. Our press release and Form 10-K, which was filed yesterday, will provide extensive detail on our financials. So I'll focus on some key highlights. Overall, our owner-direct revenue transition continues to track well with the owner-direct revenue segment up to 43.6% of the consolidated revenue for the full year. More importantly, the owner-direct revenue segment accounted for 58.8% of the consolidated gross profit for the year. We closed the year with a solid fourth quarter. Most notably, adjusted EBITDA for the quarter was $11.6 million, resulting in adjusted EBITDA for the full year of $31.8 million, which exceeded the high end of our guidance. Our free cash flow conversion as a percentage of adjusted EBITDA was approximately 78% for the quarter and 74% for the full year. Focusing on the income statement, our gross margin continued to trend positively. Consolidated gross margin during the fourth quarter was up to 20.4%, resulting in a full-year gross margin of 18.9%. This success continued to be underpinned by our strategic focus on our higher-margin owner-direct revenue segment, which accounted for 44.6% of the fourth quarter consolidated revenue compared to 30.8% in the year-ago quarter. As I mentioned earlier, for the full year, owner-direct revenue accounted for 43.6% of consolidated revenue, up from 28.6% in 2021. SG&A expense in the fourth quarter was $21.8 million, up $3 million from the year-ago period. Full-year SG&A expense was $77.9 million, up $6.4 million from the prior year. Digging into the significant driver of the net increase in our SG&A, the majority of the $6.4 million increase from 2021 to 2022 was the full-year effect of SG&A expense from the Jake Marshall entities, totaling approximately $5.9 million. We have also made strategic investments in 2022, which are reflected in the SG&A of the owner-direct revenue segment, consisting primarily of salespeople and supporting staff. Given that segment's general profile of quicker-turnaround small dollar value work than has historically been the case with General Contractor work, it requires more selling and transactional support to grow relationships and drive revenue. Those investments were also a factor in the increased SG&A for the full year. When looking to model 2023 SG&A, the full year should run at a similar rate as a percentage of revenue to 2022. Consistent with our prior year, our revenue in the second half of the year is expected to be stronger than in the first half, which will cause SG&A expense to be a higher percentage of revenue in the first half of the year. In addition, the first half of the year will include non-recurring CEO succession costs associated with the transition announced in January. These costs are expected to be over $1 million, with the majority hitting in Q1. These costs will run through SG&A and will adjust our EBITDA calculation, impacting net income and earnings. Additionally, during 2022, the restructuring that took place to wind down our Southern California operation in the General Contractor segment in Eastern Pennsylvania negatively impacted our income and earnings before income taxes by approximately $6 million. While the majority of those costs and distractions are behind us, there have been some delays in wrapping up certain projects and claims, and we will see some continuation of costs into 2023. Once those are completed, we expect to see a positive impact on the business, particularly in our gross margins. The fair value of contingency consideration for the Jake Marshall acquisition also negatively impacted net income and earnings in 2022. However, the first earn-out target was met as of December 31, 2022, which is very positive as it was well earned by the Jake Marshall team for exceeding their planned EBITDA for the year. For 2023, we expect minimal expense related to the earnout, as the majority is already accrued on the balance sheet. Turning to cash flow, as we have discussed before, we expect our free cash flow conversion to continue to be approximately 70% of our adjusted EBITDA when viewed on an annual or trailing 12-month period. Given the nature of our business, cash flows can be volatile over short periods, so we urge everyone to focus on a 12-month period or longer when evaluating our cash flow performance. Our owner-direct revenue shift is having the intended effect on our operating cash flow performance. Fourth-quarter operating cash flow was $12.4 million and full-year operating cash flow was $35.4 million. The primary use of cash generated continues to be the reduction of debt. We paid down $13.4 million of our term debt during 2022. As of December 31, total debt outstanding was $31.8 million and total cash was $36 million, which allowed us to finish the year with a net debt balance of zero. We also used $2 million during Q4 on our share repurchase program, repurchasing approximately 180,000 shares of our common stock. As Charlie mentioned, we also settled one of our outstanding claims in Q4 equal to the carrying value of the claim that was in the contract asset account on the balance sheet as of September 30. Therefore, there was no impact to the income statement, and the customer was billed for the amount in Q4, which is now included in accounts receivable as of December 31. We expect to receive the cash payment of approximately $10 million for this receivable in the first half of the year. This leaves us with two claims outstanding with a total gross value of over $30 million. I want to remind everyone that the outcome of those settlement negotiations is something we cannot forecast, including the terms of the settlement amount and the timing of when cash will be collected. Our balance sheet is strong, and with the business expected to continue yielding free cash flow, we currently expect to have the strategic flexibility to pursue our acquisition program without needing to resort to equity financing. As part of our capital allocation strategy, we continue to evaluate and discuss additional share repurchase programs with our Board of Directors. I'll now hand it back to Mike.

Michael McCann, COO and Incoming CEO

Thank you, Jayme. As noted in our press release, we are introducing financial guidance for 2023. We expect full-year revenue to be in the range of $490 million to $520 million. We also expect adjusted EBITDA to range from $33 million to $37 million. Underpinning the confidence in our outlook for 2023 and also for the next several years, there are a few key drivers to note. First, the outlook of our industry remains favorable. Demand for building construction, retrofit, maintenance, and service is strong and is expected to remain so for the foreseeable future. Limbach is focused on being disciplined in working with customers where their systems are mission-critical and have needs regardless of the macroeconomic environment. In these types of buildings, owners can defer large capital expenditures, but they can't avoid immediate repairs. This allows us to flex between repairs of existing equipment and infrastructure upgrades. The second leg of our thesis rests on our positioning of Limbach based on a differentiated business model that combines engineering, craft labor, and a partner approach, all of which create value for our customers. I want to emphasize this point; we believe we're creating a unique differentiated model that combines elements of traditional non-residential construction, building service and maintenance, energy services, data analytics, and property management. We have talked for some time about our customer relationships, and my focus as CEO will be to maximize those relationships as we work to be an indispensable partner to our customers through our provision of cross-disciplined products and services. As shown on Slide 10, as our building owner customer relationships evolve from reactive transactional relationships to a proactive trusted adviser, we expect additional opportunities for further margin expansion. We have a tremendous customer base that we've built over the last few years, and we are focused on delivering value for them, which allows us to drive an appropriate return on our assets here at Limbach. Third, our balance sheet is in excellent shape, providing us strategic flexibility to pursue quality acquisitions while also investing in the growth of our business. We've done a lot to reduce our risk and improve our cash dynamics, which sets us up well to attack our strategic plan. We have built a large pipeline of opportunities, but we'll continue to be very selective, ensuring that each potential acquisition has proper synergy with our strategy. We learned a lot from our successful integration with Jake Marshall. We have built an integration team and will aim to apply some of those same principles to future acquisitions. As shown on Page 12 of the investor deck, there are four key areas where we look to improve the quality of earnings post-acquisition: data-driven decision-making, implementation of standard operating systems, solution selling to owners, and a niche-based customer mindset. When we consider the state of the market, it's evident that in recent years, particularly in response to supply chain issues, building owners have become more attuned to the need for value-added service and maintenance of their building systems. This has created an excellent opportunity for us at Limbach to leverage our relationships with these building owners, making us an indispensable partner in helping them extract maximum value from their physical assets. Our long-term opportunity centers on our ability to provide engineering, service, maintenance, and project work, much of which is rooted in data analytics. The utilization of data will enable us to work with our customers to identify and design optimal systems for those assets, further solidifying our value as their partner. We are confident we are uniquely positioned due to our combination of a disciplined approach, engineering solutions, and craft expertise. We are still in the early innings of this shift in our business. Achieving a 50-50 segment revenue mix in 2023 will be an important milestone, but it is just that—a milestone on a much longer journey. In closing, I want to thank Charlie and wish him the best for what lies ahead. Charlie, it has been a pleasure working with you. With that, operator, please open the Q&A.

Operator, Operator

Thank you. Our first question comes from Rob Brown with Lake Street Capital. Please proceed. Rob, your line is live.

Rob Brown, Analyst

Hi Mike, thanks for taking my question. First question is congrats on the first quarter on the quarter. First question is about the demand environment, what are you seeing in terms of the real-time demand environment? Are you seeing a shift more towards the service and maintenance side of the business? Has that become more pronounced, or could you provide a sense of how the demand environment is playing out into '23?

Michael McCann, COO and Incoming CEO

Good morning, Rob. In terms of the demand environment, one of the things that's really helped us is the vertical markets we focus on, from healthcare to data centers to industrial facilities to higher-end life sciences— we see tremendous demand. Our ability to zero in on our key customers and dedicate resources is helping us now and will continue to do so in the future, regardless of whether they need to repair a lot of small equipment or manage large capital infrastructure positions. We believe we have effectively positioned ourselves for success in these mission-critical sectors, and we are excited about the future of demand in these areas.

Rob Brown, Analyst

Okay, great. And then some of the margin trends looked quite good in the quarter. How do you see those continuing into '23?

Michael McCann, COO and Incoming CEO

In our owner-direct revenue segment, we've maintained margins of 25% to 28%. We did raise the General Contractor range from 12% to 13% to 12% to 15%. Therefore, we consider this a significant opportunity for margin improvement. To expand on this, we believe we are still in the early stages of developing relationships with many of these building owners, and while some have transitioned to more trusted partnerships, the opportunity exists beyond the margin range we've designated because this will rely on evolving those relationships. On the General Contractor side, we've been able to increase the margin range because, as our business transitions to being more owner-direct, this allows us to be extremely selective, and consequently, we can demand higher margins. I credit much of this to our local operators, who are ensuring that we maximize the return on our teams— this is driving us toward higher segment returns on our owner-direct work. So, we expect this trend to continue moving forward. However, there is still further opportunity for margin expansion in both owner-direct and General Contractor segments.

Rob Brown, Analyst

Okay, great, thank you. I'll turn it over.

Operator, Operator

Our next question comes from Chip Moore with EF Hutton. Please proceed.

Chip Moore, Analyst

Good morning, thanks. I guess first, Charlie, best wishes and Mike, congrats on the new role.

Michael McCann, COO and Incoming CEO

Thank you.

Chip Moore, Analyst

You talked a bit about coming in as a new CEO, but I'd love to hear you expand on what you see as the biggest focus area— a continuation of execution like you've been doing or any new focus areas? In relation to that sort of Limbach 3.0 slide, getting to 50% to 70% owner-direct revenue over time, I assume that contemplates acquisitions, but I'm curious about your thoughts there?

Michael McCann, COO and Incoming CEO

Sure. We're excited about being set up to reach the 50-50 mark two years early in 2023. As you mentioned in that Limbach strategy, we plan to extend beyond the 50-50 threshold in owner-direct revenue compared to General Contractor work. From a strategic viewpoint, there are many opportunities for us to evolve our offerings. Right now, as I mentioned earlier, much of our focus is on establishing trusted relationships, but we also see significant long-term value here. We are dedicated to our top accounts, focusing on assigning account management resources in order to gain their trust. As we foster these relationships, our customers will share more information with us about their businesses— this could include utility data, asset information, or analytics from our platform. This visibility will enhance our ability to offer solutions to those customers, enabling us to transition from a reactive to a proactive stance. This will benefit both our businesses and give us a better understanding of their long-term spending decisions. Ultimately, there's a lot of potential within Limbach 3.0 that you referenced.

Charlie Bacon, CEO

Chip, yes— with the customer base that we have today, in many instances, our customers have multiple locations, multiple buildings, and multiple campuses where we are currently working on just one campus or in one building. Therefore, our core focus right now is on account management, really expanding that or, as we say, gaining more wallet share with these existing customers. This expansion happens naturally when we establish a trusting relationship— they tend to just introduce us to their other buildings. So that's one of our key areas of focus moving forward—to really maximize revenue opportunities from our existing customer base. We've already invested in building that relationship; now it's time to expand it.

Chip Moore, Analyst

That's helpful, Charlie. You mentioned organic investment in the owner-direct revenue space— should we expect continued strategic investments there, as well as acquisitions that might help enter new markets?

Michael McCann, COO and Incoming CEO

Yes, Chip. From an organic perspective, we've recently expanded our business development resources, which will now shift focus toward account management. We have invested substantially in building a customer base, and now, as we move forward, the emphasis will be on enhancing those relationships rather than acquiring new ones. In addition, we are looking at our growth strategies, which do include acquisitions. We are quite enthusiastic about the success of the Jake Marshall acquisition— it exceeded our expectations. In the past six to eight months, we have been actively working on building a robust acquisition pipeline. Within that pipeline, we’ve identified two styles of acquisitions: one category zeroes in on ODR-centric companies, and finally, we will look at geographic expansions to explore markets east of the Mississippi. Although we have several geographic gaps, the potential is significant. Overall, our acquisition pipeline is very promising. We have learned a great deal from Jake Marshall, and our team is well-prepared to apply those lessons to future acquisitions.

Chip Moore, Analyst

Fantastic. One last question on the guidance— I assume it's around a 50-50 split for the year between owner-direct revenue and General Contractor work. I want to confirm that. Additionally, any commentary on the expected second-half strength would be helpful, considering what we saw in 2022.

Michael McCann, COO and Incoming CEO

Yes, we are projecting a 50-50 split for 2023. As for the revenue split, there has been a natural seasonality to our business, following the same cadence we've observed over the last couple of years. Typically, the back half of the year is a little stronger than the front half. So, the same cadence holds true for us going forward. Jayme, would you like to add to that?

Jayme Brooks, CFO

Yes, we are targeting that 50-50 split, and keep in mind that SG&A should be relatively similar as a percentage of revenue to what we reported previously. However, we should expect to see it higher, given that stronger second-half revenue. Thank you.

Chip Moore, Analyst

Perfect, thank you. I'll hop back in the queue now.

Jayme Brooks, CFO

Thanks, Chip.

Operator, Operator

At this time, I would like to-- we do have a follow-up question. One moment please. At this time, I will turn the call back over to management for closing comments.

Michael McCann, COO and Incoming CEO

Thank you, everybody, for your continued interest in Limbach. We're really excited about our strategy. We feel like we're in the early innings of it, and there are many opportunities as we move forward as well. So I'd like to thank everybody for their interest and all the employees of the company for their successful execution in '22 and look forward to '23. If you have any questions, please reach out to our investor relations firm. All the best.

Operator, Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.