Dycom Industries' (DY) CEO Steven Nielsen Presents at D.A. Davidson Engineering and Construction Conference (Transcript)

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Dycom Industries Inc. (NYSE:DY) D.A. Davidson Engineering and Construction Conference September 8, 2016 10:00 AM ET


Steven E. Nielsen - President and CEO

H. Andrew DeFerrari - SVP and CFO


John B. Rogers - D.A. Davidson & Company

John B. Rogers

All right. Good morning everybody. We’re going to get started this morning. Our first presentation is Dycom’s Steve Nielsen and Drew Deferrari are going to be giving the presentation.

But I’d just start up by saying while most T&C companies that we heard from, certainly are cyclical businesses, always question, where we are in the cycle. Dycom’s been probably the one company over the last couple of years that showed the most dynamic organic growth. So looking forward to the presentation. Steve?

Steven E. Nielsen

Well, thanks, John. Here we go. All right, just want to remind everybody that this presentation contains forward-looking statements, which are subject to risk and uncertainties that are more fully described in our SEC filings, which we recommend for your reading.

We’re leading supplier of specialty contracting services to wireline, cable and telephone companies and wireless carriers. We operate throughout the U.S. and in Canada. We have approaching 13,000 employees. The quarter we just reported, our fiscal July year end had 14 weeks, because we are 52, 53 calendar but just under $800 million in revenue, and organic growth rate of 20%; non-adjusted EBITDA margin of 16% and GAAP or adjusted diluted earnings per share of a $1.64 compared to $0.97 in the year ago quarter. A strong financial profile with over $400 million of availability on our revolving credit facility and cash on hand.

So I wanted to start this morning by trying to set the context in which we see our opportunity here in the U.S. We very much see and have seen over our long career that the networks that we install and maintain are fundamental to economic process -- progress, that the fiber, the capacity of the network is the foundation globally for both wireline and wireless networks.

It’s somewhat counterintuitive but as wireless has become the conduit for more data, it has spurred significant expansion in the wired network. And that consumer demand for applications is really what’s been driving the deployment of bandwidth to meet that need. And so here in this chart we just show right across the developed world, how much more there is to do, not only here in the U.S., driven by these fundamental drivers but also across Europe, Australia and East Asia.

And so one way to highlight that is not to talk about our customers here in the U.S. but talk about analogous carriers in Canada. So here we provided some quotations from the last earnings season in Canada, talking about the fiber deployments of Bell Canada, Telus, the responses from John Rogers and we just thought it was interesting to see that the drivers, the fundamental drivers that we see in the U.S. that we think reflect global realities around the business are evident just north of the border.

To try to size the opportunity here in the U.S. the way we typically think about the business is there’s about a 125 million or a 130 million homes passed in the U.S. We think there is robust competition between at least two providers in every market. So multiply that by two and say a target opportunity of about 250 million passings for those providers. And typically the industry has thought about 75%, 70% to 80% of those passings will be economic to supply with fiber, or a very high bandwidth communication network.

And so here you can see that number comes to just under 200 million in terms of total potential opportunity that we’re at about 26 million today. And so when people try to size the opportunity, the longevity of the opportunity we think it’s big and that we’re in the early stages of deployment.

We are in a business that has had a long secular driver. Here you can see charted on slide seven the growth in network traffic charted against economic growth. And so it’s an up and to the right phenomena irrespective over the last generation of changes in the macro-climate that’s as fundamental as any trend in the economy.

We see a number of strength in the end-market drivers. So we talked about the telephone companies deploying fiber-to-the-curb and fiber-to-the-node to enable one gigabit connections; cable operator deploying to small and medium enterprises, expanding network capacity, expanding their network for newbuild. Wireless carriers that have been augmenting the enhancing the 4G capacity and coverage are now beginning to augment that with some 5G strategies.

We have a government program called the Connect America Fund Phase II, where the FCC is actually providing annual funding from now through 2021 to a number of our customers to deploy high bandwidth networks in those parts of the country that would not be economic absent the subsidy.

And as our customers have merged, and there have just been couple of mergers in the cable industry, that have concluded this calendar year, there have been opportunities created by those mergers, and as our customers get larger, they have drivers to consolidate supply chains, which has created some market share opportunity. So overall, it’s an encouraging environment.

So a little bit more about the drivers. Here you can see both AT&T and CenturyLink have declared multiyear programs through 2019. In AT&T's case they have committed to the FCC as part of the DIRECTV merger to deploy fiber to 12.5 million incremental homes passed. They are just on their way. They provide updates on each of their quarterly calls.

CenturyLink just came out about a month ago with a 2017 through 2019 plan to both enhance their fiber-to-the-home network by adding about 1.8 million homes passed, from where they are today, in addition to doing a number of enhancements to their copper network to facilitate bandwidth growth.

Fiber for cable operators and small and medium enterprises has been a huge opportunity. It’s something that really started six or seven years ago. So Comcast $5 billion business today is something that probably was well less than a $1 billion, five, six years ago. And so here you see with the Charter Time Warner merger, that we have two growing customers in this area. We have grown our wireless business. We completed an acquisition about two months ago now, that expanded that footprint more broadly across the country, and we see a number of opportunities. But interestingly the wireless business is the quotation here from Verizon indicates is, they are talking about enhancements to the wireless network that "rely on putting extra strands in the ground of fiber."

So it’s one of things that has, particularly the 5G, as you create all of that bandwidth capacity, you got to push the wired connection much closer to the eventual subscriber. And so a convergence of the wireline and wireless networks that will be going on for a generation is really just beginning.

The Connect America Fund as we talked earlier, it’s a substantial initiative, provides steady funding for our customers. We announced on our last earnings call, a couple of weeks ago that we have seen a number of projects across probably 12 or 14 states. We see that accelerating into Calendar 2017.

So as you can tell from the focus of the presentation, we’re really all about telecom, 90% of the revenue of the business comes from telecom. For cable companies, everything from the head end facility through the fiber and coaxial cabling, to in-home installation work; for telephone, everything from the central office to the subscriber; for wireless, everything from tower, action [ph] lines and the antenna to test and turn-up [ph].

So a broad business. We do have a small business, where we do provide underground facility, locating so that when excavators call before they dig we are the folks that will go out for the existing facility owners and identify the locations of the underground utilities.

We operate the business through local brands. We think this is important. We want to be as big or as small as a customer wants us to be for an opportunity. We have had decades long relationships that are crucial in the business to our competitive position. I always talk about Nashville, Tennessee, where we have served a telephone company in that part of Tennessee continuously since 1954 with one brief one year hiatus in the early 1980s.

And so it just goes to show the power of the relationship through multiple generations of our management as well as the customers' management.

As we look to grow the business, we want to make sure that we’re anticipating technology trends that drive capital spending. We want to make sure that we work for those customers that have solid businesses, that pay us on the operating cash flows. And we found that those incumbent customers over long periods of time have generated the vast majority of industry opportunities.

We do, do acquisitions occasionally. It is not something that we have to do. But when we see an opportunity to expand our footprint, or growing our relationship base with the customers we’ll certainly do that. And then certainly, given the growth in the business and the scale that we have, want to make sure that we continually improve the way we operate the business by expanding our margins and getting better at providing valuable service to our customers.

We do have a Blue Chip customer base. Here you can see for the quarter that we just reported at the end of July, the breakdown of that customer base. And it’s nice to have a very solid Blue Chip investment grade for the most part of the customer base. So we worry about getting the work done, not whether we’re going to get paid for what we do.

Now in our industry, given the amount of merger activity, if you look at our top five, six, seven customers, now those customers 15-20 years ago probably would have been in excess of 20 different customers. So we’ve had a consolidating end market. And when you do that you are going to get some customer rotation, and you are going to get some concentration. And our view is as long as we provide solid valuable service to those customers, as they get larger, that we are more than amply paid for that concentration risk and the economic returns that we generate for our shareholders.

One of the things that’s somewhat different from a number of the companies, that will be presenting today is that about 80% of our business is from multiyear master service agreements, and other long-term contracts. These are contracts that are generally described in tasks, rather than individual projects. They are more like service agreements then they are a traditional construction contract. And in fact we disclosed, I think in our 10-K that we had something in the order of 5% of our revenue that was accounted for under percentage of completion and the vast majority of the 95% that remains we literally discount what we do each day. Each task as a price. We extent [ph] the quantity of complete versus that price and that’s how we earn our revenue.

So we literally have businesses where we look at revenue generation every day to see what the trends are in the business. We had strong backlog growth as we’ve had good organic growth. They have gone hand-in-hand and backlog at the end of the fourth quarter in total was just over $6 billion.

It’s important in any public business, under public company to understand management’s view towards capital allocation, and since I have been doing this now for 20 years we just looked at the last 10, because hopefully you learn as you get older and here you can see that first and foremost we've spent the greatest proportion of our operating cash flow and net leverage increased over the last 10 years on capital expenditures.

We are always going to first and foremost reserve capital to organically grow our business, and then with the balance of that cash flow we have done a number of acquisitions and balanced that with substantial share repurchases. So in this particular case you can see kind of our priorities over a long period of time supported by robust operating cash flow. I think over that period of time we’ve probably reduced shares outstanding to the tune of about 30% net of all equity issuances, including those to employees.

So just to summarize again the industry themes, there are dramatic increases in bandwidth underway on networks, both underway and in planning. We are doing that work across vast portions of the country, that’s accelerating. We’re encouraged when we see customers like CenturyLink rolling out multiyear plans for their shareholders, that tells you how strategic it is to them, the services that we provide. We think we are clearly in the -- that 2015 was the foundation of an expansion in the size of the business. We think 2016’s performance has amply supported that view and we think that the both the scale of the company and our financial strength position us well to take advance of the opportunities that we see in the marketplace.

So with that I will turn the slides over to Drew.

H. Andrew DeFerrari

Okay, thank you everyone for joining us. We've continued to generate strong revenue, earnings growth and cash flows. Most recent quarter we had just over $789 million of revenue, which was about 20% organic growth year-over-year. That produced strong margins and EBITDA. EBITDA was over a $100.6 million or 16% of revenue for the period, and EPS was a $1.64. We’ve got a strong financial profile, which I’ll walk through on subsequent slides. We’ve got a strong balance sheet and cash flows. In the quarter we generated a $182 million of operating cash flow. We used that cash flow to pay for two acquisitions, totaling $108 million in the period.

We also supported all the CapEx in the period, and we paid down our revolver, paid off the revolver balance in the period. So strong cash flow generation. And then as Steve mentioned, we’ve got a capital structure designed to produce strong equity returns. During fiscal 2016, we did repurchase about 2.5 million shares for a $170 million, an average price of just over $67 a share.

Fiscal 2016 revenues were $2.67 billion. If you compare that back to the fiscal '12, when the revenues were about $1.2 billion, it’s been 22% CAGR over that period of time. As you can see at the bottom, we’ve had organic growth for the last five years, of just over 22% for the full fiscal year of 2016.

We do have a little bit of seasonality in the business. So our Q2 and Q3 quarters, most of the work we do is outdoors. So we will be impacted by weather and available workdays. So you’ll see a little bit of oscillation there in the quarters. But during the fiscal year, we did increase revenue in each of the quarters. We had strong organic growth, as you can see in the chart at the bottom.

Those revenues produced strong EBITDA in the most recent fiscal year. We had $390 million of EBITDA, which is about 14.6%. And if you think back to the revenue growth that we had, which is about 22% CAGR, we’re able to grow the earnings faster than that. So the EBITDA grew at about a 30% CAGR over the last five years, and EPS grew at about 40% combined annual growth rate. So solid returns there.

And then, as you can see in the upper right, the EBITDA in each of the four quarters not only increased in dollars year-over-year, but also as a percent of revenue. In the most recent quarter we are at 16% EBITDA.

We got a strong balance sheet and liquidity. Our liquidity was just over a -- just at $426 million at the end of the July quarter. That consisted availability on the credit facility and cash on hand. We have no near term debt maturities, and we’ve got a revolver that goes through April 2020 with lots of capacity on that as well as senior convertible notes that are at 0.75% coupon that go through 2021.

And then as you can see, we’re able to reduce the revolver borrowings down to zero over the period. And then we’ve been able to officially convert our earnings into cash flow, which you see there. Our operating cash flows for the full fiscal year were just over $260 million, and that supports – that along with the availability, supports a strong foundation for growth.

So our strong balance sheet, solid cash flows and our long-term confidence in the industry outlook help drive our capital allocation strategy. As Steve mentioned, first and foremost, we’ll support organic growth. We did grow at 20% in the most recent quarter. And that takes capital to do. We are happy to invest, to continue to grow the business.

Secondly, we’ll pursue complementary acquisitions. We’ve completed a number of acquisitions in most recent few years. We did several in 2015 and 2016, as you can a see a total of about $189 million of acquisitions. And then lastly, share repurchases, really this is since fiscal 2016 -- or since 2006, so going back 11 years, we purchased -- repurchased 23 million shares for $579 million. And considering that we only have 32 million shares outstanding now, you can see that we've significantly reduced the future equity claims on earnings. That’s all during the time period, where we have significantly grown revenue and we do have an authorization available for October 2017 as you can see here.

Then with that, I’ll turn the presentation back to Steve.

Steven E. Nielsen

Okay. So John, I guess we have time for some questions. John, we’ve got a mic there for you.

Question-and-Answer Session

Q - John B. Rogers

The first question I have is -- there has been a lot of reports in the press about Google slowing down, and I know it’s not one of your main customers, but I just wondered how much of a leader are they in the market and a driver for this spending. Because they certainly seem to get a lot of press relative to it.

Steven E. Nielsen

Well, certainly they are a big financed company, right and so they're always going to have lots of press, because they do lots of interesting things in a number of different industries around their core business. I think what I would tell you is they've certainly got some large projects underway. So there is certainly some clamor [ph] on resources in the industry. But what we said in our presentation, and I think is a view that's been formed over a long period of time, is that there is huge in-place investment from the incumbent carriers that require lots of spending as they upgrade the network. So I have not seen any number in terms of what Google's total aspiration is on what they're deploying. But if you look at AT&T's commitment and CenturyLink's commitment to 15 million homes passed by the end of 2019 in a country where kind of since Verizon started a little over 10 years ago we're only at 26 million.

So you can see that there are tremendous programs that are in place, not only for somebody like Google but certainly from the incumbents including Century Link's plan, which is really just something that they committed to about a month ago.

I think the other thing that we tried to highlight in the slides, were I think, when you see, and we saw this in the 90s when you see new entrants into a marketplace it's dominated by large incumbents that's generally an expression that there is an underlying demand for more bandwidth, that, that new company feels like they can meet. And so often times I think we've gotten the discussion backwards with respect to Google.

My view is that they're responding to the same factors for consumer demand for high bandwidth that the incumbents are. And as opposed to, so they are the effect of the consumer demand, they are not the cause of other people spending because they're all reacting to the same environment. And that's why in Canada where they're not active you have the exact same dynamic as you have here in the U.S.

John B. Rogers

And then my second question is and you showed the slide there about the consolidation of your customers. There also 10 years ago there were a lot, there were more players in the marker, more competitors as well. And I'm just wondering with the strength of this market, how easy is it for somebody to start up in this business, and what are the barriers to entry here?

Steven E. Nielsen

So I think there is -- clearly if you have capital and there is attractive returns on capital you are going to attract some competition right. And I think we've seen that in this industry and lots of other industries. But what I would highlight is that it really is a business, that as our customers have consolidated, their reliance upon suppliers has become more strategic to them. And so I often say that if you look at the example I gave in the presentation of serving a customer for 62 years, there clearly must have been some kind of defensible barrier to competition or a way to protect the market so long as we provide a good, cost affordable, high quality service right. That's what competition should make you do. It should make you get up every day and figure out how to be better.

I think given the scale of the opportunities right now and given the fact that the industry in aggregate does not have enough capacity to meet all of the customers' needs that have been expressed. So we're in a growth environment that's reflected in our organic growth. I think that makes it in some ways more difficult for competitions to emerge because it's very difficult to differentiate your service at scale when you have to grow resources. And that's one thing that we're pretty good at. We've done it for a number of years for a number of customers as we know how to manage these large programs and cost effective way to provide additional resources.

John B. Rogers

And sorry, one other question, you showed some slides up there about the relative penetration in various geographic markets. Have you looked at going outside of the U.S. particularly?

Steven E. Nielsen

We're like any other public company. We take a look at those things periodically. But when you see that we grew 20% organically in a year. So $400 million or $500 million of revenue, it's here, it's with customers. We understand people that we've served for a long period of time and through business units that we're highly confident in their ability to execute. Right now I think the right thing to do is just to really figure out how to stay close to home and do as good a job for our customers as we can.

John B. Rogers

Any other questions?

Steven E. Nielsen

Other questions?

Unidentified Analyst

I got a couple of them…

Steven E. Nielsen


Unidentified Analyst

In terms of acquisition opportunities versus capital spending, in your expansion that way, are there still small, I mean regions that you don’t have covered in that you’d like or the customers are asking you to expand your presence in areas?

Steven E. Nielsen

We don’t have ubiquitous coverage. So there is always some parts of the country we can get a little better at. There’s always relationships, I mean we’ve done a number of acquisitions in the last year, where we acquired businesses that worked for existing customers and hopefully we helped them get better, we helped them grow through access to capital which is always an issue for private companies that are trying to fund rapid growth.

And I always learned, in every business you acquire, no matter how small, there’s always something that you have an open mind and you think about their business in the way you do to evaluate the buyer, that you learn something. And so it’s a continual infusion of some kind of new DNA right into the company that we’ve always found that’s been helpful support to the major theme which is growing organically. The best returns on capital are always going to be investing in working capital by supporting our customers and buying capital equipment and tooling, that’s always going to be the best thing to spend our money on, and when we have cash flow beyond that, it’s helpful to do acquisitions.

Yes sir?

Unidentified Analyst

What technological [Question Inaudible].

Steven E. Nielsen

Yes, I’ll just repeat the question. So the question is what technological development could be a threat to the business model long term? I think that the standard answer to that Gary over last 25 years would have been wireless, and it would have been completely wrong at every stage, right because actually particularly with the advent of the iPhone ten years ago, the amount of fiber that’s been deployed just to support the explosion of wireless data has been something that’s certainly I did not predict. So there may be a time where that changes. Our customers are big. They have networks, that go back a hundred years plus. They’re usually pretty good at anticipating these things and that’s not what I hear our customers saying.

So I can tell you, when we meet with our management team twice a year I often tell them that we really been blessed by staying close to home with a business model that although the scale of it is much greater, the value of the business is much greater, but it’s really the same business model that we managed ten years ago and 20 years ago, which has identified great customers that have long term investments to make on a recurring basis, and then provide great services at the right price and we worry about a lot of execution things. We don’t worry about a lot of strategic issues because the business has been so consistent over a long period of time.

John B. Rogers

Steven, I can’t remember whether it was the last conference call you said it or somebody else talked about the amount of data that even on a wireless network that goes through the fiber?

Steven E. Nielsen

On 4G network about 90% of the path is fiber or some wired communications. The early prognosis on 5G is it maybe 95%, 96%, 97%. I mean it’s kind of like thinking about the infrastructure in your home. You may connect through Wi-Fi but unless you’ve got that coaxial fiber to the side of the house you’re not going to have the capacity that you need and I think we’re going to see that dynamic play out writ large, when our customers make big generational investment decisions. They have not, in my experience doing this for almost 30 years, they haven’t been wrong.

Now tactically every once a while there may be a wiggle. But if you think about it in broad themes our customers make these decisions with the 30, 40, 50 year outlook and they generally have gotten it right. So that’s comforting to us in terms of our deployment.

John B. Rogers

And then maybe for Drew as well, the proportions that you showed over the past ten years in terms of capital allocation, and given the significant improvement in your earnings over the last two years, should we still think about capital allocation the same way, or does this give you more capacity for buybacks, I guess because you wouldn’t have or is capital expenditures going to ramp with earnings?

Steven E. Nielsen

Well, we certainly have had some ramp in capital expenditures over the last 12 to 24 months, as we -- to support the organic growth. Now what's interesting about that is clearly when you expand your footprint, that kind of growth requires a new set of capital right in the first year that you do it, the second year not so much. And so we can have some growth with the capital. We started a large contract for a customer in a major West Coast City in the fourth quarter of last year. All that capital went into last year, the growth is going to be in this year.

And I think what’s interesting, John and since we do the conference every year, I look back at some of John’s numbers from two years ago, and it doesn’t feel like it’s 1918 yet, but I mean maybe that’s we are at 1917. I think we had 1917 in 2015 but anyway 2016 and 2014 or however those numbers worked out right. And so I think we’ve had lots of earnings growth. But I think the discipline in the business is shown right that the cash flows and the investment and the margin growth, had we maintained discipline even when the top line has grown, and let’s face it that’s always a tough thing in a service business. We have had to hire thousands of people, making sure that we don’t go -- we’re not over exuberant in terms of where we commit those resources too, so that we actually maintain good service levels for our customers and the right profile on margins I think is just a testament to not only Drew, but the rest of the organization because growth isn’t easy and disciplined growth is really not easy, particularly in a service business.

John B. Rogers

And then in terms of margins, I mean you have seen substantial top line growth, you have seen margin growth as well how should we think about margins? I don’t know if you want to call it mid-cycle or long-term average because you are just kind of getting back to the levels that we saw 15 years ago or…

Steven E. Nielsen

Yes, so to some degree the margins are a reflection on the growth opportunity right. And so as we are growing the business and investing in capital, not only us but the entire industry, so our customers are investing. They all, to the extent that they have folks to support these big programs themselves they are adding employees and capital equipment. So we are all investing and in order to make sure that that investment is there for the industry you have to have the right return profile and that expresses itself as margins. I think the good thing about the business and the backlog in the business is that as we set the right price in order to grow that capacity and commit to our customers of supporting them that’s built into the backlog in a way that a lump sum project business and we’re traditional E&C 6 months or 12 months or 18 month project at the time, that’s not the way this business works. I mean it’s built into the business. We’ve got to grow the capacity to get the work done. But it’s three and four and five year commitments in a way that you don’t see in other parts of the business.

So always say that we have kind of two objectives one is half of the business is lower than that margin. So you are constantly looking at your portfolio, and trying to figure out, either are these opportunities that somebody else might be better off doing than you are. And that’s been part of the margin growth right is the ability to be very careful where you commit to provide good service to customers, as you can just figure out how to run the business better. We have a number of technology initiatives we deploy one in a good size business and took out about 300 basis points of cost on a flat year-over-year of revenue.

John B. Rogers

Sorry, what was the technology…

Steven E. Nielsen

It’s just, it’s all around the flow of managing the productivity and the technician workforce right and they are just great things that these wireless businesses, wireless capabilities can do to somebody who manages the distributor workforce. I mean we've got one program that I guess we have 3,000 people on, and they are probably on something like 75 job sites, maybe 100, over four states, figuring out how to manage that type of workforce effectively and not with a lot of the incremental, what I call cost of goods overhead. That’s an important thing to do. Those are the things that our scale can create that smaller private or even public competition just not going to have the focus on the business that we would on those types of initiatives.

John B. Rogers

And what do you see in terms of availability of employees? I know that a year ago you substantially ramped hiring in training in…?

Steven E. Nielsen

Yes, I think labor as you'd see when you are at some 5% unemployment, there is going to be on the margin there is going to be some tightness around labor. I stopped on a couple of operations headed West this week and certainly hiring and growing the employee base is first and foremost there is a great example John of some technology we deploy which is not unusual in broader business but as far as I know fairly unusual in our industry where we have now gone to an online, on-boarding process and we’re getting to generate a couple of thousand applications a week that we can go through to grow the business. That’s the level of visibility that we didn’t have in the prior cycles.

So hopefully we get, as we get over and as we see these things develop we get smarter about how we manage them.

John B. Rogers

All right

Steven E. Nielsen

All right, thank you very much.

John B. Rogers

Thanks Steve.

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