All improvement: Dycom Industries Management Discusses Q2 2014 Results

Executives

Steven E. Nielsen - Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Richard B. Vilsoet - Vice President, General Counsel and Corporate Secretary

H. Andrew DeFerrari - Chief Financial Officer, Chief Accounting Officer, Senior Vice President and Treasurer

Analysts

Saagar Parikh - KeyBanc Capital Markets Inc., Research Division

Victor W. Chiu - Morgan Keegan & Company, Inc., Research Division

Adam R. Thalhimer - BB&T Capital Markets, Research Division

John B. Rogers - D.A. Davidson & Co., Research Division

Noelle C. Dilts - Stifel, Nicolaus & Company, Incorporated, Research Division

Alexander J. Rygiel - FBR Capital Markets & Co., Research Division

Christian D. Schwab - Craig-Hallum Capital Group LLC, Research Division

Alan Mitrani

Dycom Industries (DY) Q2 2014 Earnings Call February 26, 2014 9:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Dycom Results Conference Call. [Operator Instructions] And as a reminder, today's call is being recorded. I'll turn the conference now over to your host, Mr. Steven Nielsen. Please go ahead.

Steven E. Nielsen

Thank you, John. Good morning, everyone. I'd like to thank you for attending this conference call to review our second quarter fiscal 2014 Dycom results. During the call, we will be referring to a slide presentation, which can be found on our website, www.dycomind.com, under the heading Events. Relevant slides will be identified by number throughout our presentation.

Going to Slide 2. Today, we have on the call Drew DeFerrari, our Chief Financial Officer; and Rick Vilsoet, our General Counsel. Now, I will turn the call over to Rick.

Richard B. Vilsoet

Thank you, Steve. Referring to Slide 3. Except for historical information, the statements made by company management during this call may be forward-looking and are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements, including those related to the company's outlook, are based on management's current expectations, estimates and projections and involve known and unknown risks and uncertainties, which may cause the company's actual results in future periods to differ materially from forecasted results. These risks and uncertainties are more fully described in the company's annual report on Form 10-K for the year ended July 27, 2013, and other periodic filings with the Securities and Exchange Commission. The company assumes no obligation to update forward-looking statements. Steve?

Steven E. Nielsen

Thanks, Rick. Now moving to Slide 4 in a review of our second quarter results. As you review these results, please note that we have included adjusted EBITDA, certain revenue amounts excluding revenues from acquired subsidiaries and storm restoration services, certain expense amounts excluding acquisition-related costs and write-off of deferred financing costs and adjusted earnings per share, all of which are non-GAAP financial measures to our release and comments. See slides 13 through 16 for a reconciliation of the non-GAAP measures to the GAAP measures in the slide presentation provided for this call.

As we stated in our prerelease of February 10, results for our second quarter were sharply impacted by adverse weather. Revenue for the quarter increased year-over-year to $390.5 million, an increase of 5.7%. After excluding revenues from acquired subsidiaries from this quarter and the year-ago quarter and $16.7 million of storm restoration services in the year-ago quarter, revenue grew 0.9% organically. Gross margins declined 219 basis points year-over-year, reflecting major snowfalls and extremely cold temperatures, which reduced the number of available work days and negatively impacted productivity.

Including integration cost of approximately $700,000, general and administrative expenses, after excluding prior year acquisition cost, increased 94 basis points year-over-year as a percentage of revenue, reflecting underabsorption of expenses as a result of weather-impacted revenues. All of these factors produced adjusted EBITDA of $28.2 million for the second quarter or 7.2% of revenue, and a net loss of $0.09 per share for the second quarter compared to a non-GAAP net income of $0.15 per share in the year-ago quarter.

Operating cash flow was strong in the quarter at $86.6 million, with cash and availability under our current credit facility totaling $215.6 million. During the quarter, we repurchased 360,900 of our own shares at an average price of $27.71. Overall, despite adverse weather, industry trends were solid.

Going to Slide 5. During the quarter, we experienced the effects of an industry environment, which we believe continued to improve. AT&T was our largest customer at 18.7% of total revenue or $73.2 million. AT&T grew 38.5% organically year-over-year. Revenue from CenturyLink was $56.4 million or 14.4% of revenue. CenturyLink was our second largest customer. Revenue from Comcast was $47 million or 12% of revenue. Comcast was our third largest customer and grew organically 12.3%. Verizon was Dycom's fourth largest customer for the quarter at 8.3% of revenue or $32.4 million. Revenue from Time Warner Cable was $23.3 million or 6% of revenue. Time Warner was our fifth largest customer and grew organically 23.2%.

Altogether, our revenue grew 0.9% after excluding revenues from acquired subsidiaries in the current and prior quarter, as well as storms. This represents our 12th consecutive quarter of organic growth. Our top 5 customers combined produced 59.5% of revenue, growing 11% organically, while all other customers decreased 13.6%. Of note, organic revenue, excluding projects funded in part by the American Recovery and Reinvestment Act of 2009, grew 4.6%.

Now moving to Slide 6. Backlog at the end of the second quarter was $2.147 billion versus $1.996 billion at the end of the first quarter, an increase of approximately $151 million. Of this backlog, approximately $1.193 billion is expected to be completed in the next 12 months. Both backlog calculations reflect solid performance as we continue to book new work, renew existing work and anticipate substantial future opportunities.

For CenturyLink, we renewed 3-year construction and maintenance services agreements for New Jersey, Virginia, Tennessee and North Carolina. With AT&T, we renewed construction and maintenance service agreements in Alabama and Georgia. For Comcast, we renewed construction and maintenance service agreements in Michigan, Massachusetts, Connecticut, New Jersey, Pennsylvania, Maryland and Virginia. From Questar, we received a 3-year extension to our construction services agreement in Utah. For Duke Energy, we secured a new 3-year construction services agreement in South Carolina. And finally, we secured rural broadband projects in a number of states, including Nebraska, Wisconsin, Tennessee, North Carolina and Georgia. Headcount decreased during the quarter to 10,410, primarily reflecting seasonal patterns.

Now I will turn the call over to Drew for his financial review and outlook.

H. Andrew DeFerrari

Thanks, Steve, and good morning, everyone. As a reminder in today's conference call materials, there is disclosure of certain non-GAAP measures, including items such as organic revenue growth, adjusted EBITDA and non-GAAP EPS. In the materials, we have provided a reconciliation of these non-GAAP measures to the comparable GAAP measures.

Going to Slide 7. Contract revenues for Q2 of 2014 were $390.5 million, including revenue from acquired subsidiaries of $111.5 million. Adverse weather during the latter part of the fiscal quarter sharply impacted our results. Adjusted EBITDA of $28.2 million was down compared to $37.2 million in Q2 '13. And we incurred a loss per share for the current quarter of $0.09 per share compared to non-GAAP net income of $0.15 per diluted share in Q2 of '13.

Turning to Slide 8. As a reminder, the Q2 '13 amounts included only 8 weeks of results for those businesses we acquired in December of 2012. The Q2 '14 amounts include a full quarter of results for all of the acquired subsidiaries. So as you review the results, please note that there are several variances due to our increased scale.

On an organic basis, revenue grew 0.9% from increases with several key customers, including wireless and cable operators. Growth was partially offset with declines in services for rural customers and due to the impact of adverse weather. G&A depreciation and interest were all up year-over-year as the businesses acquired in fiscal 2013 were included for a full period this year. Gross margins, EBITDA and net loss were all impacted by the extreme weather conditions experienced during Q2 this year.

Turning to Slide 9. Our balance sheet remains strong, and we increased liquidity to $215.6 million during the quarter. Operating cash flows were solid at approximately $86.6 million even after making our semiannual interest payment of almost $10 million on our notes, and after making required estimated tax payments near $21 million during the quarter. Capital expenditures net of disposals were $16.5 million, and gross CapEx was approximately $19 million. On our senior credit facility, we paid down $58.6 million during Q2 and ended the quarter with $26 million of revolver borrowings and $118.8 million of term loan borrowings outstanding. During Q2, we repurchased 360,900 shares at an average price of $27.71 for $10 million. At the end of Q2 2014, we had approximately 33.8 million shares of common stock outstanding.

Now going to Slide 10. As we look ahead to the third quarter of fiscal 2014, we anticipate revenues which range from $415 million to $435 million, and reflect the impacts of adverse weather conditions experienced during the first fiscal month of the quarter that began on January 26, 2014. Gross margin percent seasonally impacted, but expected to expand from the Q3 '13 result. Total G&A expenses, which reflect increased scale and are expected to include stock-based compensation of approximately $3.2 million. Depreciation and amortization is expected to range from $22.3 million to $22.8 million, including amortization expense of $4.1 million in Q3 '14.

Interest expense is expected at $6.6 million. Other income from asset sales is expected near $3 million. Taxes are expected to continue near a 40% effective rate. The applicable factors are expected to generate an adjusted EBITDA margin percentage, which is essentially in line with the Q3 '13 result, and earnings per share, which is currently expected to range from $0.19 to $0.26 per share. We expect approximately 34.7 million diluted shares during Q3 '14, with shares gradually increasing at subsequent quarters reflecting the future vesting and value of employee equity awards.

Now going to Slide 11. As we look to Q4 of 2014, we have included our outlook with a focus on those factors which most impact earnings per share on a quarterly basis, revenue and margins. Our expectations currently reflect the following: Low-single digit total revenue growth as a result of continued wireline improvements by a key customer; cable construction which strengthens; and services to wireless carriers, which remain robust. Gross margins, which expand year-over-year from an improving mix of customer growth opportunities; G&A, which reflects increased scale and includes noncash compensation of approximately $3.2 million; EBITDA margin percentage, which slightly expands year-over-year from margin improvement and greater operating efficiencies accompanying revenue growth. Other factors influencing results include depreciation and amortization, which ranges from $22.3 million to $22.8 million; interest expense, which declines to $6.5 million; and other income from asset sales in the with the Q4 '13 amount.

Now I will turn the call back to Steve.

Steven E. Nielsen

Thanks, Drew. Moving to Slide 12. Within an improving economy, we experience the effects of a solid industry environment and capitalized on our significant strengths. First and foremost, we maintain solid customer relationships throughout our markets. We continue to win projects and extend contracts at attractive pricing. Secondly, the strength of those relationships and the extensive market presence they have created have allowed us to be at the forefront of evolving industry opportunities. The end market drivers of these opportunities remain firm and are strengthening. Telephone companies are deploying fiber-to-the-home and fiber-to-the-node technologies to enable video offerings. And in some instances, 1 gigabit high-speed connections. These deployments are accelerating and impacting our business. Some of those telephone companies deploying fiber-to-the-node are expanding fiber-to-the-home trials, while others have initiated larger deployments. Cable operators are continuing to deploy fiber to small and medium businesses with an increasing urgency. Some are doing so in anticipation of the customer sales process. In one instance, a cable operator has indicated that it is exploring combining some fiber-to-the-home deployments with its fiber-to-the-business initiatives. Overall, cable capital expenditures are expanding.

Wireless carriers are upgrading to 4G technologies, creating meaningful growth opportunities in the near to intermediate term, as well as planning to increase macro cell density. Industry participants continue to aggressively extend fiber networks for wireless backhaul services. These services are now planned for small cells, as well as macro cells. Limited pilot surveys for initial small cell deployments are underway. Dramatically increasing wireless data traffic may prompt further wireline deployments. As we look out over the intermediate term, we are increasingly encouraged that these current end market drivers are clear signals of an emerging industrywide consensus that network bandwidth, both wireline and wireless, needs to increase dramatically in response to consumer demand and competitive realities.

We are encouraged that we've already seen some limited impact of this emerging consensus on our business. Previous periods in which industry consensus has changed sharply, such as dial-up to broadband, broadband to fiber deep or fiber to the home, and cellular voice to wireless data have been accompanied by significant growth opportunities for us. We are hopeful that this looming transition may be as or more rewarding than previous industry consensus transitions given our scale, market position and capital structure. Among service providers of our size or larger, we believe we are uniquely positioned, managed and capitalized to meaningfully experience an improving industry environment to the benefit of our shareholders.

We remain encouraged that our major customers possess significant financial strength and are initiating or remain committed to multiyear capital spending initiatives, which, in some cases, are meaningfully accelerating. We remain confident in our strategies, the prospects for our company, the capabilities of our dedicated employees, and the experience of our management team, who have grown our business in capitalization many times before.

Now, John, we will open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll first go to the line of Saagar Parikh with Keybank Capital Markets.

Saagar Parikh - KeyBanc Capital Markets Inc., Research Division

First off, I wanted to get some color, you guys mentioned you went through all your different market opportunities. I know last week Google announced that they're going to be expanding their Google Fiber network to 34 cities. Steve, could you just -- I don't know how much in detail you can go into it, but from what you can at any level, just give us an idea of what you think the market size could be for you guys and opportunities set there?

Steven E. Nielsen

Sure. I think there is a couple of things that are important to note about the Google announcement last week. #1, it's really 9 DMAs that they talked about so the 34 cities are clustered in 9 geographic regions across the country. And what's important to note is that those are fairly widely dispersed, so everything from the East Coast through the middle part of the country onto the West Coast. And 8 of those 9 DMAs were actually working for an incumbent provider cable or telephone company, or in some instances both. So it shows kind of the breadth of our coverage of the industry that it matches well with what Google has announced. I think the other thing that's important to note is that it is supportive of our view that kind of this consensus around the 1 gigabit connection being kind of the standard or what people aspire to in the near term, I think, is clearly evident. In fact, I think they also have talked in their announcement that they may even be thinking about a 10 gigabit product down the road. So clearly it shows that demand for bandwidth is something that they feel is going to be sustained. And in terms of the opportunity for us, I mean, we really don't have any specific comments other than to say that clearly in the past when a consensus has changed around what competitive bandwidth needs to be provided, that there are tremendous opportunities for the company.

Saagar Parikh - KeyBanc Capital Markets Inc., Research Division

And then could you guys tell us if you've done any work for Google yet in Austin, Kansas City or in Utah?

Steven E. Nielsen

I mean we're not going to comment in any specific way of whether we work for them or not at this point.

Saagar Parikh - KeyBanc Capital Markets Inc., Research Division

Okay, no worries. And then lastly, on your capital allocation, you had $10 million in buybacks in the quarter, paid down $59 million in debt. Can you just give us an idea of how you're thinking about your capital and your cash going forward?

Steven E. Nielsen

Sure. So we continue to have some acquisition opportunities that we're looking at. I think it's always going to be a case of looking at, first, what we need to support organic growth to the extent that we see large projects coming down the path. We want to make sure that we have a good balance sheet, and we do, and adequate financial capability to tackle anything that comes along. I think then we'll look at acquisitions that expand our footprint and relationships versus share repurchases based on valuation. It's just -- it's an art, not a science. But we want to make sure that we make the company not only bigger, but better, and part of better is making sure we have the right capital allocations.

Saagar Parikh - KeyBanc Capital Markets Inc., Research Division

Okay. And then sorry, last question from my end. With that Time Warner Cable, Comcast potential deal, is there any worry that them going through a potential M&A process could end up weakening or having Time Warner come back on their CapEx and then that could impact your build plans?

Steven E. Nielsen

Yes, I think there's a couple of things to note. So we work for both Comcast and Time Warner. In fact, we work for Comcast now for 17 years from the time that they went from having 3 million or 4 million subscribers to potentially 30 million. And generally, throughout all those M&A transactions, they have been pretty consistent that as they've got larger, they deployed capital that continued to improve their network and competitive positioning. So we're not -- we are encouraged with Comcast's involvement with Time Warner. I think secondly, the Time Warner folks have pretty clearly articulated that while they go through the approval process of the merger that they have rolled out a 3-year plan at the end of January, and they plan to execute against that. And as we -- as I noted, it included a significant increase to CapEx. So it's a little hard to see that in a weather-impacted quarter, but we have no reason to believe that they won't do exactly what they've been saying.

Operator

Our next question is from Simon Leopold with Raymond James.

Victor W. Chiu - Morgan Keegan & Company, Inc., Research Division

This is actually Victor Chiu in for Simon Leopold. I just want to get a few housekeeping questions out of the way. Can you give us the breakdown for the segments for telco cable and et cetera?

Steven E. Nielsen

Sure, Victor. I'll just start by giving you the next 5 on the customers as well. So Windstream was at 6% -- #6 at 4.6% of revenue. Charter was #7 at 4.4% of revenue. Customer #8 was at 1.8% of revenue, and this is for a customer that has requested that we not identify them by name. Customer #9 was Frontier at 1.6% of revenue, and customer #10 was Ericsson at 1.4% of revenue. Telco was 62.4% and cable was at 24.6%.

Victor W. Chiu - Morgan Keegan & Company, Inc., Research Division

Agreed. And the utility and the electric?

Steven E. Nielsen

Sure. It was at 7.5%.

Victor W. Chiu - Morgan Keegan & Company, Inc., Research Division

Great. I wanted to ask about your guidance for your April quarter. It seems that your sales guidance for the April quarter has come down from your initial outlook in November presumably from the weather impacts from the beginning of the quarter. But your gross margin continues to imply improvement from the third quarter of '13. So can you just provide some color around the mix there and what's impacting gross margin particularly, given your speciality growth, soft gross margin this quarter?

Steven E. Nielsen

Yes, as with anything, Victor, there's always a mix shift. And in this particular case, there are shifts towards projects and customers where we see a little better margin opportunities overall in the business. And clearly, the third quarter, particularly when you recall that the quarter starts the last week of January for us, continue to have some weather impacts in February, and a little bit even past our prerelease of February 10. So, I mean, we feel good about the margin profile of the business and given the opportunities with the gross prospects are in the intermediate term.

Victor W. Chiu - Morgan Keegan & Company, Inc., Research Division

Okay. I mean, if the impact was really strictly the weather, will it be reasonable to expect that the April quarter would reflect unseasonally better growth, better growth maybe to reflect kind of catching the outcome?

Steven E. Nielsen

Remember, Victor, it includes February. And the other thing is, and it's clearly a good question, right? So to the extent that we've had weather impacts at the beginning of the calendar year with customers who have calendar year budgeting, right, for those things that are capital driven, we expect that they'll spend their budgets. So nobody is going to -- at the end of the year, say they didn't spend their capital budget, because they got to a slow start because of the weather. Seeing where that comes through throughout the year, we're just going to be conservative on seeing exactly how that plays out, because it does impact their planning process a little bit in the beginning of the year. The other thing is, there is a portion of the business that's maintenance and kind of more economically sensitive. And so we'll just have to see what that does to the first quarter GDP and how that comes back through and the rest of the year. But on the capital side, the customers will spend their budgets. In fact, as I'm sure you're aware, a number of our cable customers essentially all raised their capital budget. So I'm not sure they're going to spend it.

Victor W. Chiu - Morgan Keegan & Company, Inc., Research Division

Well, your headcount, I wanted to ask, also declined quite a bit this quarter by nearly 700. But you're emphasizing that the fundamental growth remains strong.

Steven E. Nielsen

I don't think it declined exactly that much, but it's a seasonal impact on the business. There was a little bit of rotation between contracts, but primarily seasonal.

Victor W. Chiu - Morgan Keegan & Company, Inc., Research Division

Okay. So it's not a reflection of your outlook or anything with that or...

Steven E. Nielsen

No.

Operator

And next we'll go to Adam Thalhimer with BB&T Capital Markets.

Adam R. Thalhimer - BB&T Capital Markets, Research Division

Wanted to ask first about Slide 12. Steve, I mean, your -- it seemed a little bit more bullish about the end market drivers now sending clear signals of a emerging industrywide consensus. And I'm just curious what -- is there something you're seeing on the engineering side of your business that would lead to that optimism?

Steven E. Nielsen

Well, I wouldn't say specifically the engineering, Adam. But if we think back since we last spoke kind of at the end of November, and you think about the number of industry announcements that I have focused on expanding capital budgets and expanding 1 gigabit wireline deployments, I just think that we've seen -- it has not been surprising to us that the capital spend came out -- the guidance from our customers has come out the way it has, nor that they continue to be focused on significantly increasing bandwidth to residential consumers. So I just think we continue to see confirmation. AT&T last year had announced the Austin project for 1 gigabit fiber to the home. Several months ago, they expanded the footprint of that opportunity. We also pay attention to customers like Time Warner that not only raised CapEx, but provide a 3-year outlook, so that when you see multiyear plans being articulated, that's a good way to measure confidence and conviction around the spend by our customers. So I just think that the data is pretty universally indicated that opportunities are increasing, and that the consensus around kind of where bandwidth needs to go continues to head up to 1 gigabit.

Adam R. Thalhimer - BB&T Capital Markets, Research Division

And what are your thoughts on -- right, because every single cable customer that you work for has CapEx of 15% to 20% this year projected. And then when do you really start to feel that? What's the timing on that?

Steven E. Nielsen

Well, there's a couple of things, right? So we're going to see that in project flows. They go through a planning cycle. And so it usually doesn't show up the first week of January. And this year with the weather, it certainly didn't. But I think you'll see them accelerate the spend throughout the year, particularly once we get past these weather impacts. There are certainly elements in that CapEx, particularly at 1 customer that are heavily around going all digital and increased CPE deployments, and our subsidiaries in that business have seen that begin to pick up. But we would expect that it would be something that would accelerate throughout the year.

Adam R. Thalhimer - BB&T Capital Markets, Research Division

I guess, because the only thing that confuses me a little bit with your guidance, which for the next 2 quarters is at or in line -- or I would say in line with or above consensus. The only thing surprising a little bit was the Q4 revenue guidance of low-single digits. And I'm curious, is there anything that's holding you back given that kind of customer CapEx growth?

Steven E. Nielsen

Yes, and I think there, Adam, that clearly the headwind to the extent that there is a headwind, a tactical headwind in our environment, is that you have the stimulus roll-off. And then in the subsidiaries that we acquired in December of 2012, they really outperformed our original revenue expectation for the first 12 months post-closing. But we do expect them to settle somewhat as they were more heavily focused on stimulus-related projects. So I just think it's kind of a normal rotation that you see occasionally, although the stimulus that's rolling out in terms of the original magnitude of the spend in -- for folks like ourselves are certainly going to be much smaller in a shorter duration than the trends that we see more globally throughout the rest of the industry.

Adam R. Thalhimer - BB&T Capital Markets, Research Division

Okay. And then just lastly for me, I mean, I wanted to take one more shot at the engineering side of the business. I mean, is there anything -- are there any big programs that you see coming that we don't know about?

Steven E. Nielsen

Well, if they were not...

Adam R. Thalhimer - BB&T Capital Markets, Research Division

Maybe they're just trends like small cells, something like that.

Steven E. Nielsen

I mean, clearly as we noted in our comments, Adam, I mean, we have seen some limited pilot surveys for small cell deployments. I think the technology is still shifting around a little bit. There's absolutely pretty universal conviction that, that will be deploying probably latter half of '14 into '15 and accelerating, because it's an important part of all of the wireless carrier strategies. So, yes, we're seeing opportunities. They are real opportunities. They have specific geographies. They're just not ripe yet to talk about, or to incorporate in a significant way in our future outlook. But there's good reason for us to be optimistic.

Operator

Our next question is from John Rogers with D.A. Davidson.