Construction Partners, Inc. Q3 FY2023 Earnings Call

Thank you, operator, and good morning everyone. We appreciate you joining us for the Construction Partners conference call to review third quarter results for fiscal 2023. This call is also being webcast and can be accessed through the audio link on the Events and Presentations page of the Investor Relations section of constructionpartners.net. Information recorded on this call speaks only as of today, August 2nd, 2023. So please be advised that any time sensitive information may no longer be accurate as of the time of any replay listening or transcript reading. I would also like to remind you that statements made in today's discussion that are not historical facts, including statements of expectations or future events or future financial performance, are considered forward-looking statements made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. We will be making forward-looking statements as part of today's call that by their nature are uncertain and outside of the company's control. Actual results may differ materially. Please refer to today's earnings press release for our disclosures on forward-looking statements. These factors and other risks and uncertainties are described in detail in the company's filings with the Securities and Exchange Commission. Management will also refer to non-GAAP measures, including adjusted EBITDA. Reconciliations to the nearest GAAP measures can be found at the end of our earnings release. Construction Partners assumes no obligation to publicly update or revise any forward-looking statements. And now, I would like to turn the call over to Construction Partners' CEO, Jule Smith.

Thank you, Rick, and good morning everyone. With me on the call today are Greg Hoffman, our Chief Financial Officer, and Ned Fleming, our Executive Chairman. We are pleased to report an excellent quarter. In fact, it was a record quarter for CPI in numerous ways. I want to thank our over 4,000 employees for their hard work and expertise in delivering this record quarter, despite battling wetter-than-normal conditions. Our employees are the key to our success at CPI. Not only did they deliver a great quarter, they also continue to set the table for future growth and success by adding strong backlog throughout our six states and establishing several growth initiatives, which we will cover on the call today before Greg reviews our financial information. Q3 represented the single highest revenue quarter in our history at $422 million. As evidenced by our gross margins of more than 15%, our teams throughout 67 local markets were productive and efficient. When comparing year-over-year revenue, it's important not only to take into account the above-normal precipitation this quarter, but also the abnormally hot liquid asphalt index adjustment last year that produced $10 million of additional revenue. CPI continues to produce strong organic and acquisitive growth and our revised guidance announced today reflects an anticipated annual growth of over 18% in FY '23. As anticipated in the third quarter, substantially all of our work came from post-inflationary backlog. Additionally, the company benefited from lower energy costs. The result of the hard work, backlog conversion, and some lower costs with strong gross margins, net income, adjusted EBITDA, and cash generation. Gross margins were 355 basis points higher than a year ago and adjusted EBITDA margin was 13.4%, a high single quarter margin in over two years. Cash flow from operations continues to be strong as CPI's model has historically generated free cash conversion of over 50% which is available to invest in growth initiatives and compound shareholder value. In addition, we made significant progress in lowering our leverage ratio during the quarter. As we stated last quarter, our business is normalizing and we are now experiencing operational performance typical for CPI. We continue to pursue healthy sources of recurring revenue in a much more stable and normal cost environment. The expectation is for the business to maintain this performance trajectory. A great indicator of future growth is our growing backlog even though a record revenue quarter. Historically CPI's backlog might shrink in the busy work season, the fact that our teams produced a record backlog for the 10th quarter in a row is evidence of growing relative market share in our local markets and continued strong demand in both the public and private markets. The IIJA’s investment in public infrastructure is now in effect throughout our states in creating opportunities for road widenings and resurfacings, bridge replacements, airport taxiways, and many other types of good opportunities for CPI. In the private markets, migration to the Southeast United States continues to produce demand for our services in industrial, non-residential, and residential projects. A record backlog gives us great visibility into the future and allows us to remain patient in adding high-quality new work at attractive margins. Turning now to CPI strategic growth model, we announced this week two growth initiatives. First, we acquired a hot-mix asphalt plant and related operations in Myrtle Beach, South Carolina from C.R. Jackson. We entered this market a year ago. We've been very impressed with the dynamic growth and opportunities in the second fastest growing metro area of South Carolina. This acquisition gives our local team additional resources to capitalize on those opportunities and grow our relative market share. Second, as we continue to focus on organic growth, we announced this week a new hot-mix asphalt greenfield in Waycross, Georgia, a strategic location adjacent to our current South Georgia markets. This greenfield will allow us to extend our reach eastward for the rapid growth emanating from the large port in Brunswick, Georgia. And finally, one of our key levers of margin expansion is vertical integration and I'm pleased to announce that our new liquid asphalt terminal in North Alabama is now operational. This terminal will capture the margin dollars between wholesale and retail while servicing over 12 asphalt plants in Alabama and Tennessee just as we have been successfully executing for four years with our Gulf Coast terminal and the Panhandle of Florida. Before I turn the call over to Greg, I want to conclude by reiterating how pleased we are with the quarter and the outlook for the remainder of FY '23 as demonstrated by raising net income and adjusted EBITDA ranges. As we look to FY '24 and beyond, it's great to see the resilience and quick recovery of the CPI model operating effectively. The company is ready for and benefiting from opportunities afforded by generational investment in infrastructure, a booming economy in the Southeast, and numerous growth opportunities as we consolidate and strengthen our industry. We are indeed excited for the road ahead. I'd now like to turn the call over to Greg.

Thank you, Jule, and good morning everyone. I'll begin with a review of our key performance metrics in the third quarter of fiscal 2023 before discussing our raised outlook ranges. Q3 revenue was $421.9 million, an increase of 10.5%, compared to the same quarter last year. Excluding $10 million of additional revenue from liquid asphalt index reimbursements in the third quarter last year, due to the large increase in asphalt prices, revenue growth was 14%. Gross profit was $64.1 million, an increase of approximately 45% compared to the same quarter last year. As a percentage of total revenues, gross profit was 15.2% in the quarter, compared to 11.6% in the same quarter last year. General and administrative expenses as a percentage of total revenue in the quarter were 7.6%, compared to 7.7%, in the same quarter last year. In Q3, net income was $21.7 million, an increase of 78%, compared to $12.2 million in the same quarter last year. Adjusted EBITDA was $56.4 million, an increase of 50%, compared to the same quarter last year. The adjusted EBITDA margin for the quarter increased to 13.4%, compared to 9.9% in the same quarter last year. You can find GAAP to non-GAAP reconciliations of net income and adjusted EBITDA financial measures at the end of today's earnings release. In addition, as Jule mentioned, we are reporting a record project backlog of $1.59 billion at June 30th, 2023. Turning now to the balance sheet. We had $55 million of cash and cash equivalents and $182 million available under the credit facility, net of a reduction for outstanding letters of credit. We have $277.5 million principal outstanding under the term loan and $143.1 million outstanding under the revolving credit facility. It is unchanged from March 31st except for term debt payments of $3.1 million. The availability on our credit facility and cash generation will continue to provide flexibility and capacity to allow for potential near-term acquisitions and high-value growth opportunities. As a reminder, the company entered into an interest rate swap agreement that fixed SOFR at 1.85%, which results in an interest rate on $300 million of term debt of 3.35%. This is a reduction from 3.6% in prior quarters due to the decrease in our leverage ratio, which improved our surface spread. The maturity date of this swap is June 30th, 2027. As of the end of the quarter, our debt to trailing 12-months EBITDA ratio was 2.27. Our expectation is that the leverage ratio will continue to trend downward at the fiscal year-end. Cash provided by operating activities was $48.8 million for the quarter, compared to the use of $13 million of cash in Q3 FY '22. For the first three quarters of fiscal 2023, we have generated $94.5 million of cash flow from operating activities. Capital expenditures were $18.6 million for the quarter. We continue to expect capital expenditures for fiscal 2023 to be in the range of $85 million to $90 million. This includes maintenance CapEx of approximately 3.25% of revenue with the remaining amount invested in high-return growth initiatives. Historically, we have converted retained cash flow in the range of 50% to 60% of adjusted EBITDA after subtracting interest expense and taxes. We are on target to generate that amount in 2023. Retained cash flow has been invested in attractive long-term investments. This generated 22% adjusted EBITDA growth in the last fiscal year, despite a challenging macro environment. And this year is on track to generate 45% to 50% growth in adjusted EBITDA. These investments include the Alabama liquid asphalt terminal, expanding into Waycross, Georgia, and acquiring an HMA plant in Myrtle Beach, South Carolina that Jule mentioned earlier. As we continue to utilize this retained cash for high-value growth investments, we expect margins to increase, organic growth to continue, and shareholder value to compound. Today we are tightening our revenue range and raising our net income and adjusted EBITDA ranges for our fiscal year 2023 outlook and we now expect revenue in the range of $1.535 billion to $1.555 billion, net income in the range of $41 million to $46 million and adjusted EBITDA in the range of $161 million to $169 million. And with that, we are now ready to take your questions.

Thank you. We will now be conducting a question-and-answer session. Your first question comes from Tyler Brown with Raymond James. Please go ahead.

Hey, good morning guys.

Good morning, Tyler.

Good morning, Tyler.

Congrats on the quarter. Jule, is there any way you could quantify just how much weather did cost during the quarter? I mean I don't normally ask because I get it, the weather is a part of the business, but it just seemed like it was awfully wet this quarter, particularly in April. I think it maybe highlights just how strong the underlying business is.

Yes, Tyler. There was a report that said in our local markets when measured around each of our asphalt plants, the precipitation was 30% higher than normal or 130% of normal. So I think that's pretty accurate. And we can't quantify exactly how much that is, but I would just say it was significant, but the good news is our crews and our people pulled through it and delivered a great quarter, and with record revenue. Clearly, the revenue would have been higher if we'd had typical weather, but I was really impressed to see the margins come through, and I think that's what we anticipated and even with the precipitation we had that was a great result.

Yes. Interesting. Okay, great. We're going to get to margins in just a moment, but real quick, Greg, did you mention the M&A contribution to revenue for the quarter?

It was roughly 3%, but I'm sorry, the acquisitive contribution was 10%. I thought you were asking about organic growth, yes, that's 10% acquisitive.

Okay, 10%. Perfect. Going back to the asphalt adjustments, I understand there was a $10 million contribution last year. Was there a negative adjustment this year? It seems that to reach the 3% drag, there must have been a negative impact this year.

No, actually in the earnings release, we had revenue reconciliation for both this year and last year, it's about a $1.5 million pickup for this year, so $8.5 million delta year-over-year.

Okay. All right. I'll take a look at that. And just maybe lastly here, I kind of do want to come back to margins. So I know this may be hard, but you mentioned 350 basis points of improvement year-over-year but can you kind of unpack what drove that? I mean, if we think about a margin bridge. I mean I know that there was lower zero-margin index revenue adjustments. So maybe that was a help, lower energy prices were help but I'd surmise that even with those tailwinds core margin still rose.

Yes, Tyler. We mentioned that as energy costs decrease, it's somewhat beneficial, but overall, it's more about the Consumer Price Index returning to normal. We have been working through a backlog that was affected by pre-inflationary conditions, and now we can bid based on known input costs. This shift is reflecting in our results. Essentially, we are getting back to our standard practices. Most of the margin improvement comes from building work, and we are seeing that jobs are finishing with margins higher than our bids, which is typical. So, that would account for most of the improvement. Regarding the backlog, I’m not sure about specifics, but it's really just about getting back to our usual backlog levels.

Okay. Perfect, thank you guys so much for your time.

All right, Tyler. Thank you.

Thank you, man.

Your next question comes from Kathryn Thompson with Thompson Research Group. Please go ahead.

Hey, good morning. This is actually Brian Biros on for Kathryn, thank you for taking my question.

Hey, Brian, good morning.

Good morning, everyone. To start, I believe the press release mentioned that IIJA is fully implemented. Can you provide more context about what that means today? Are you seeing new projects on the ground that are funded by IIJA, or is it mainly funds going into design and engineering, or supporting projects that are already in progress? What does that situation look like now and in the future for you?

Yeah, Brian, good question. IIJA clearly is a big deal. It's a generational investment in infrastructure for our industry. It's a five-year plan, as we all know it started later than expected and so it's really the lettings in our states, really just started happening last fall in this past winter on a regular basis. So I would just say that we're seeing it come through in the lettings. It is funding projects. I don't think it's going to be as impactful this year as it will be next year. I think you're going to continue to see a ramp-up and this is going to provide five years of really good demand, and it's not just roads, it's airports, railroads, ports, charging stations, all of that infrastructure CPI is going to be able to participate in.

I understand. Building on the previous question, you mentioned a return to historical norms regarding price and cost volatility moving forward, especially after facing some headwinds over the past year. Has the workload that was established before the inflationary environment dissipated, and are we now entering a phase where we can expect to see a return to normal performance in the coming quarters, or is there anything else we should keep in mind as we approach the end of the year?

No, Brian, I really think our updated guidance reflects we feel really good about the fourth quarter. Our model is that we're estimating and bidding jobs every day and our jobs have a typical duration of nine months to a year. And so we were able to burn through that pre-inflationary backlog that we got surprised when inflation hit; it took us about a year and we're through that for the most part with very minimal left. And so we're really just seeing now the results are just getting back to our normal model, which is being able to bid jobs and the cost reflect the world as it is.

Got it. Thank you.

Okay, Brian. Thank you.

Your next question, Andy Wittmann with Robert W. Baird. Please go ahead.

Hey guys, thanks.

Hey, good morning.

Hey, I wanted to hear you, Jule, talk a little bit about labor in particular. It's been a significant factor over the last couple of years. You mentioned energy as a benefit, but can you discuss your ability to find labor and how the wages are comparing to the previous year?

Hey, Andy, labor continues to be a big topic. So that's a great question. We feel like the labor market in a sense is normalized. It's still in our industry; we have to compete for workforce, and in the long-term, as you know, we're going to have to compete as our workforce ages out and retires. We see that at CPI as an advantage. We're going to do what it takes to attract and retain our workforce. So that we can continue to grow. And so we're doing a lot of things on that, but in the short-term, I would say the labor market is really not any impediment now. We're able to find the workers we need and our local markets are doing a great job attracting labor.

Got it. I was also hoping you could comment on your view on the mix between the private sector and the public sector work that you do. Do you expect that your company is going to be doing more work in the public sector as the impact of higher rates takes hold this year and next year? So maybe address it that way or also just talk about kind of what you're seeing from your private sector customers today in terms of the bidding environment in terms of the number of bids that are out there, that you're chasing?

Yes, Andy, Greg and I noticed that the 60-40 split has remained surprisingly steady as we closed the quarter. We expected it to trend upwards with IJAA, but it continues to hover around that 60-40 division between public and private. This suggests that the Southeast private market is holding steady. We haven't observed any significant decline in private opportunities, as businesses continue to enter the Southeast. Now, I’ll hand it over to Ned to discuss the bigger picture, but I want to emphasize that the split has remained quite consistent.

Andy, I think one of the things we've done well for 20-plus years is we're in growing markets. I mean if you come to Greenville or you go to the markets that we're in, they're all growing, and there is a housing shortage. So there is a supply issue with houses, it's not an interest issue, it's a supply issue. There are more people who want to buy houses, even though the interest rates are up, and there are homes today, and we see that in market-after-market that we participate in. So I think the private markets and the commercial markets for us are going to continue to stay really strong because the demographic growth of the areas that we're in is growing. It's actually accelerating since COVID, so we feel really good about the fact that we continue to be able to pick projects that we want to do on both sides of that curve.

Okay, great. That's all the questions I had for today. I hope you all have a nice day.

All right, Andy.

Thank you, Andy.

Your next question comes from Adam Thalhimer with Thompson Davis & Co. Please go ahead.

Hey, good morning guys. Nice quarter.

Hey, Adam, good morning.

Thanks, Adam.

Can you provide some insights on bid margins or the margins in your backlog? I'm interested because you've experienced solid sequential growth in your backlog, which you mentioned earlier. Could you share more details about the type of work you're currently adding to the backlog?

Yes, Adam, the backlog we added this quarter had very good margins, which indicates that people are busy and the demand is strong. We are seeing healthy margins that continue to grow in our backlog. This gives us the confidence to raise our guidance for the fourth quarter and will also positively impact fiscal year 2024 and beyond.

Well, that's where I was going Jule. I was curious, maybe it's a little early, but just curious if you think you might get back to historical EBITDA margins, which I think were more like 11%, 12% on an annual basis.

Yes, FY '24 is approaching, making it a relevant time to discuss our goals. As we've mentioned, we still aim to achieve 12% EBITDA margins in '24, making significant progress towards that target. Our goal for '23 was to return to double-digit margins, and with our updated guidance, it's clear that our expectations have increased since the start of the year. We're enthusiastic about what the next year holds.

Okay. Good to hear. And then just a last one, on the M&A outlook, what's the attitude among sellers right now?

Well, I've been on the road a lot lately Adam, so M&A activity continues to be strong. We're having a lot of good conversations with potential sellers, I would say, it really hasn't changed a lot. Most of the people that we're talking to about selling, they are busy also; they have good backlogs, but our sellers are really thinking more about their long-term family planning and generational issues and that really hasn't changed. So we're excited about the conversations we're having in future acquisitions. And so it's a big part of our growth strategy, both organic growth and acquisitive. So you're going to continue to see us do acquisitions at a steady rate.

Great. I'll turn it over. Thanks.

Adam, thank you.

Next question, Stanley Elliott with Stifel. Please go ahead.

Good morning, everyone. Thank you for the question. I have a quick inquiry regarding the backlog. It's been increasing sequentially; was that due to weather, or perhaps a slower pace on the organic side? Additionally, I'm interested in the composition. We've discussed the price-cost dynamics a lot, and I’m wondering if you're bidding on larger projects. I'm curious about how everything is shaping up.

I'll answer sequentially and then I'll let Greg answer as far as the makeup of the jobs in it. I would say Stanley that weather was not a big factor in our backlog growth. We grew to a record backlog and as you know historically CPI's backlog has shrunk in the busy work season when we're burning off a lot of revenue. So the fact that we grew it over $70 million, I think is evidence of growing relative market share in just a strong demand. So I'll let Greg speak to sort of the makeup of the jobs that we're seeing in the backlog, but I would say our guys did a really good job of growing the backlog.

Yes, we track that and want to understand how our job stratification looks. If you look back to our earlier years like '18 and '19, it hasn't changed much at all. Even though we've doubled our revenue according to our guidance for this fiscal year compared to the '19 10-K, the makeup has remained the same.

Great news. You mentioned healthy sources of recurring revenue. Could you elaborate on that? Is it mainly related to the resurfacing nature of your work, or is there something else contributing to it?

Yes, Stanley. That's a great question. A key aspect of our CPI strategy is generating recurring revenue in local markets. For us, this means that the city of Huntsville will issue a resurfacing contract each year, and developers in Pensacola will undertake a certain amount of work annually. This allows us to have repeat customers who we anticipate will spend a specific amount of money, enabling us to establish local teams in our 67 markets and strengthen those relationships. This is why we experience steady revenue; it allows us to keep crews busy and develop a local workforce, knowing that there will be a consistent amount of work each year. Our recurring revenues, both public and private, indicate that we expect a reliable level of demand in each of our markets.

Perfect. And then lastly for me, it seems like some of the OEMs are talking about the supply chain getting a little bit better. Are you getting the equipment that you need, help us with kind of lead times and availability and then also kind of maybe speak to some of the technologies that you guys are implementing to help with the overall productivity?

Lead times have significantly improved compared to a year ago. While they may still be longer than historical averages, we've adjusted our ordering process and strengthened our relationships with equipment manufacturers, which has been beneficial. This year, we've sold some equipment that we previously held onto for a longer period due to lead times, marking a positive change. Regarding technology, we're continually keeping pace with advancements, whether it's through equipment that alerts us when repairs are needed or fleet tracking systems that provide real-time updates on our trucks' performance between the asphalt plant and the road. These innovations, which we couldn't have imagined five or ten years ago, are enhancing our operations and will likely help us improve our margins in the future as we work more efficiently. Staying ahead of these technological trends is a priority for us.

Perfect, guys. Thanks so much and congratulations.

Thank you, Stanley.

Thank you, Stanley.

Your next question comes from Brian Russo with Sidoti & Company. Please go ahead.

Yes, hi, good morning. I'm sorry if I missed this, but what was the year-over-year organic growth, year-over-year?

So if you adjust for the liquid asphalt adjustment, Brian, that we talked about at 3%.

Okay, and you mentioned this last quarter. How does that relate to the volumes of asphalt tons or perhaps the equipment hours year-over-year?

Brian, I would just say when we look at our volumes year-over-year, year-to-date were up pretty substantially in our equipment hours and we're up in our asphalt tons. We've had a wetter first quarter than last year, we've had a wetter third quarter than last year, so that our two biggest quarters of the three we've had so far been wetter than typical, but we are experiencing real volume increases were growing as a business. And when you look at our revised revenue outlook, it's 18% to 20% up and last year's growth of 40% to 42%. That's not the typical CPI year this is, growing 18% to 20%. And it's going to end up being about half acquisitive and half organic, which is what we historically have done.

Okay, great. And is there any difference in the margins on the private side versus the public side?

No, they're pretty comparable, Brian, the margin profile really changes more about market. Some markets have a higher margin profile than others, but when you look at public versus private they're pretty comparable.

Okay. And I suppose that you're actively involved in all of this re-shoring and electric vehicle battery facilities being built down in the Southeast I assume?

Absolutely, do re-shoring, we are working on several manufacturing facilities right now where businesses are moving into the Southeast. And then on the electric battery facility right here in North Carolina, we have Toyota building a huge battery facility just a few miles up the road from one of our asphalt plants, that's provided good work and then you have VinFast, which is building a huge electric car facility in Sanford. So, yes, and you see that throughout the Southeast, it's just a lot of businesses moving as well as people. And so that creates a lot of industrial opportunities for us to work on those sites.

Great. And then lastly, just to follow up on the IIJA spending. Obviously, the first funding rate would go to roadways and resurfacing for the DOTs to put it to work quickly and get the matching of funds. Are you seeing funds now flow into to more complex projects? You referenced bridges and maybe airports that might be bigger or more complex that might allow some higher margins.

Yes, Brian, the IIJA encompasses various types of infrastructure. Currently, we are involved in several airport projects throughout the Southeast, which are beneficial for us. Although we do not focus on mega projects, we believe that participating in larger projects, where we can act as an asphalt or grading subcontractor, is advantageous due to the lower risk and higher margins. Therefore, IIJA will generate revenue for us in multiple ways.

Okay, great, thanks a lot.

Thank you, Brian.

Thank you. I would like to turn the floor over to management for closing remarks.

Thank you, everyone, for your time this morning. We're looking forward to a good fourth quarter and talking to you again. Have a good day.

This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.